EY warns chancellor's fiscal headroom has halved to £11bn — and could turn into a £7bn deficit

The chancellor’s fiscal headroom has more than halved since the war in Iran broke out and could be wiped out entirely if the conflict persists, according to economists at EY.

Headroom stood at £23.6bn in March but is likely to have fallen to about £11.3bn by the time John Healey delivers his first budget on October 28, the Big Four firm’s economists estimate. They attribute most of the reduction to higher bond yields, which have pushed up the government’s debt-servicing costs, and rising unemployment, which has weighed on tax receipts while lifting welfare spending.

EY’s central forecast assumes the Strait of Hormuz — through which about 20 per cent of the world’s oil and liquefied natural gas is shipped — reopens within the next few weeks. But in an “adverse scenario” where the strait remains effectively closed into 2027, UK inflation would hit 6 per cent by Christmas and headroom would shrink by a further £18bn, turning the £11bn-plus surplus into a £7bn deficit, EY warns.

Peter Arnold, EY UK’s chief economist, said the chancellor now had “very little margin for error”. He added: “Over the past six months, headroom has eroded by more than half, underscoring how much of the fiscal position can be shaped by external economic factors rather than domestic policy.”

The assessment echoes Matt Swannell, chief economic adviser to the EY ITEM Club, who told Reuters earlier this month that medium-term borrowing prospects look “far more challenging than in March” and estimated headroom at just over £10bn, down from £24bn.

Headroom is the difference between what the Office for Budget Responsibility thinks the government will raise in tax in five years’ time and what it will spend. Labour has committed to funding day-to-day spending through tax revenues alone.