The new Chancellor faces a 4 per cent real spending squeeze by the end of the decade – equating to approx. 24 billion in 2023 prices – because of higher and more persistent inflation, which will create very difficult trade-offs in the next Autumn Budget, according to the National Institute of Economic and Social Research’s latest quarterly Economic Outlook.
The NIESR Economic Outlook underscores the severe policy constraints awaiting newly appointed Prime Minister Andy Burnham and Chancellor John Healey ahead of their first Budget.
The government inherits the highest borrowing costs in the G7, a fiscal consolidation heavily backloaded toward an election year, and eroding real purchasing power across public spending.
With public debt stabilising at a high level, but no path to bringing it down, NIESR stresses that any new commitments on defence and improving living standards must be funded through taxation or spending reallocations rather than additional borrowing.
With regard to growth, despite ongoing geopolitical volatility in the Middle East and renewed disruptions in the Strait of Hormuz, the UK economy demonstrated stronger-than-expected resilience in the first half of the year, prompting a slight upward revision in full-year GDP growth to 1.1 per cent in 2026 (up from 0.9 per cent projected in spring), with 1.1 per cent again in 2027.
However, NIESR warns that the second half of 2026 will see a marked deceleration as elevated energy costs compress household real incomes and lingering geopolitical uncertainty weighs heavily on private business investment.
Inflation is now expected to average 3.1 per cent in 2026, peaking at 3.8 per cent in February 2027 following energy price cap adjustments, and it will take longer to return to target (early 2029 rather than in 2028). Despite this, NIESR project Bank Rate to remain on hold at 3.75 per cent through 2026 and 2027 as labour market slackening mitigates second-round wage-price effects. Though NIESR warns that if energy prices rise further and persist, the MPC would need to raise rates.
Unemployment is forecast to rise modestly to a peak of 5.3 per cent in late 2026 before easing back to its natural rate of 5.0 per cent by late 2028.
Living standards also remain under pressure: NIESR currently projects real personal disposable income to grow by 1.0 per cent in 2026 but only by 0.1 per cent in 2027 as the higher inflation caused by the rise in energy prices kicks in.
Finally, the crisis of young people not in education, employment or training (NEET) is set to continue: NIESR projects over 1 million young Britons (16–24) to remain NEET through 2030, and argues that targeted local interventions in mental health and vocational education—not economic recovery alone—are what would shift it.
Stephen Millard, Deputy Director for Macroeconomics, said: “The UK economy proved to be surprisingly resilient in the first half of this year, but a slowdown is still to come.
“Even if peace is restored relatively quickly in the Middle East, inflation will still rise and the new Chancellor will need to make some difficult decisions with respect to how to fund the latest policy announcements, from cuts to VAT on electricity and business rates for pubs, to the £2 bus fare cap.”
David Aikman, NIESR Director, said: “Prime Minister Andy Burnham faces a challenging inheritance—eroded real spending plans, the highest borrowing costs in the G7, new spending demands and cost-of-living pressures. Debt is projected to stabilise, but there is no plan yet to bring it down.
“New commitments on defence or household support should be funded through taxation or savings elsewhere—not through further borrowing. Rebuilding the capacity to absorb future shocks will require a determined attempt to bring debt down.”
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