The Chancellor should use the forthcoming Autumn Budget to create a bigger fiscal buffer and set debt on a clearly declining path, according to the National Institute of Economic and Social Research’s latest quarterly Economic Outlook.
NIESR’s latest estimates point to an underlying fiscal gap of around £38 billion relative to the government’s rules.
While somewhat larger than the figure the OBR is expected to report later this month, the message is the same: after successive shocks, the UK government faces the urgent task of rebuilding fiscal headroom.
Years of economic shocks have left the public finances stretched, with the UK now facing the highest borrowing costs in the G7.
To restore credibility, NIESR argues that the government should aim for a safety margin of at least £30 billion (approx. 1 per cent of GDP) beyond any gap identified by the OBR – enough to provide genuine insurance against future shocks and to reduce borrowing costs by reassuring markets of fiscal discipline. Greater stability would also help to lower policy uncertainty, supporting both business investment and consumer confidence. This would likely kickstart the virtuous feedback loop that the UK economy so badly needs.
Beyond the rules, the central issue is debt sustainability. With the real interest rate now exceeding the growth rate of the economy, stabilising the debt-to-GDP ratio requires persistent primary surpluses of around 1 per cent of GDP, and larger surpluses to bring debt down. Without such an adjustment, debt dynamics act as a ratchet: each new shock lifts the ratio higher, and without determined consolidation, it never falls back.
Against this backdrop, NIESR now forecasts GDP growth of 1.5 per cent in 2025 – slightly above the estimated long-run trend of 1.25 per cent – before easing back to trend in 2026 and 2027.
While inflation remains well above target, it is expected to fall to 2.7 per cent in the second quarter of 2026 and to reach the 2 per cent target by the third quarter of next year. We expect the MPC to keep rates on hold on Thursday, with a 25-basis-point rate cut in February 2026, followed by a further cut to 3.5 per cent – our estimate of the natural nominal interest rate (r*) – later in the year.
Given this outlook, NIESR recommends that the Chancellor uses the Autumn Budget to:
- Put the public finances back on a sustainable track by ensuring debt begins to fall as a share of GDP; and
- Create a large buffer against her fiscal rules to reduce uncertainty and borrowing costs.
And that the Chancellor avoids measures that:
- Reduce productive public investment, which would weaken the UK’s long-term growth potential; or
- Complicate the tax system through numerous small changes that raise little revenue but add inefficiency.
Stephen Millard, Deputy Director for Macroeconomics, said: “The forthcoming Budget presents the Chancellor the opportunity to turn things around and take brave choices. She will likely need to break her manifesto pledge by raising income tax – rather than attempting to fill the gap by messing around with lots of changes to marginal taxes – as this would be the least bad option for the economy.
A mixture of tax rises and spending cuts is needed to put the UK economy and public finances ‘back on track’, which would in turn help the Government to focus on its mission to deliver higher economic growth and better living standards across the country.”
David Aikman, NIESR Director, said: “The trajectory of UK public debt is becoming unsustainable. Five years on from the pandemic, this is the moment to reverse that drift and start bringing debt down. Without a credible plan to reduce debt over this Parliament, the UK risks locking in a permanently higher – and potentially unstable – debt ratio. That will reduce the Government’s ability to cushion future shocks, control inflation, and invest in long-term growth.
The economics are clear; what is required now is political will – the readiness to take difficult decisions on tax and spending in this Budget in the long-term interests of the UK economy.”
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