Chancellor John Healey faces a potential £4bn hit to his fiscal headroom after a sharp slowdown in immigration prompted warnings that weaker population growth could undermine the UK’s economic and tax revenue outlook.
Analysis by the Institute for Fiscal Studies has highlighted the risks posed by declining immigration projections just two months before Mr Healey’s first Budget on October 28, when the Office for Budget Responsibility is due to publish fresh economic and fiscal forecasts.
A reduction in the government’s room for manoeuvre against its central fiscal rule would add to mounting pressure on the public finances, with the conflict in Iran having already pushed up inflation, interest rates and government borrowing costs.
Economists stressed that the eventual impact remains uncertain and will depend on a range of assumptions incorporated into the OBR’s autumn forecasts. Stronger-than-expected wage growth and the resulting increase in income tax receipts could, for example, offset some of the deterioration.
The fiscal squeeze nevertheless presents a significant challenge for Mr Healey and Prime Minister Andy Burnham as they attempt to reassure financial markets that the government remains committed to controlling borrowing amid volatility in global bond markets.
Much of the immediate pressure reflects the government’s own restrictions on work, study and family migration routes. Home Office figures released earlier this week showed a steep decline in arrivals through the skilled worker and health and care worker pathways.
Immigration has been an important source of growth in Britain’s working-age population. A sustained slowdown in migration therefore reduces the potential size of the labour force, weighing on economic output and ultimately tax receipts.
Nick Ridpath, a research economist at the IFS who has been studying the latest migration data, said the issue would be relevant to the Budget.
“It will be one of the things that play a role in the Budget. There will be a lot of moving parts from what happened between March and October.”
Mr Ridpath estimated that the potential impact on fiscal headroom could range between £1bn and £4bn, depending on how the OBR incorporates the latest population projections from the Office for National Statistics.
£4billion would be the biggest downgrade they’d be likely to do,” he noted, adding that net migration could fall by a further 50,000 a year based on more recent estimates.
Ben Brindle, senior researcher at the Migration Observatory at the University of Oxford, said the economic consequences would be felt most sharply in the short term.
“A decline in net migration will have more of a negative impact in the short term than over the longer term, so it is more of a concern for a government that’s living from Budget to Budget.”
The immigration slowdown is only one of several factors threatening the Chancellor’s fiscal calculations.
The conflict in Iran has pushed energy prices higher and contributed to an increase in interest rates, raising the cost of servicing the government’s debt.
Pantheon Macroeconomics estimates that the additional borrowing costs could reduce the fiscal buffer to about £15bn, compared with almost £24bn projected in March.
Another potential weakness is the government’s housing programme. The OBR forecast last year that Labour’s planning reforms, intended to accelerate housebuilding, would generate an additional £3.5bn in government receipts by 2029-30.
Rob Wood, chief UK economist at Pantheon, said those assumptions were now “clearly at risk” because the government had failed to meet its own targets for new homes.
There are, however, potential offsets.
Higher-than-expected inflation can feed through into stronger nominal wage growth and increase income tax receipts, providing some additional revenue for the Treasury. But the interaction between inflation, wages, interest rates, growth and migration makes the eventual size of the fiscal buffer difficult to forecast.
Mr Healey has pledged to retain the fiscal rules established by his predecessor Rachel Reeves when she became Chancellor in 2024.
Under those rules, the current budget, excluding investment spending, must be in surplus by 2029-30, while public debt as a share of GDP must also be falling by the same date.
The government’s room for manoeuvre could therefore become a central issue at the October Budget, particularly if weaker migration, higher borrowing costs and disappointing housebuilding receipts all translate into a smaller fiscal cushion.
A Treasury spokesperson said the Chancellor remained “fully focused on his priorities to boost business, help with the cost of living and support people in every postcode, underpinned by fiscal discipline and a commitment to meeting the fiscal rules with a buffer against uncertainty.
For Mr Healey, the challenge is increasingly one of managing several competing pressures at once: weaker population growth threatens the tax base, higher interest rates increase debt-servicing costs and weaker construction threatens an expected source of future revenue.
The result could be a Budget in which the Chancellor has significantly less fiscal room than anticipated only months earlier.
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