Think Tank Warns on Funding for Cost-of-Living Support

The National Institute of Economic and Social Research (Niesr) has advised the new government that there is no capacity for increased borrowing to finance cost-of-living support and defence commitments. The think tank suggests that funding for these initiatives must come from either increased taxation or cuts to public expenditure.

Inflation and Interest Rate Forecasts

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Niesr anticipates that inflation will peak at 3.8% in February 2027, a figure influenced by ongoing global events. The institution forecasts that inflation will take longer to fall back to the 2% target, projecting this will occur in early 2029 instead of the previously expected 2028. In line with these predictions, the Bank of England is expected to maintain its interest rates at 3.75% throughout 2025 and 2026.

Government Commitments and Funding Options

Prime Minister Andy Burnham has committed to leading a government focused on the cost of living. His administration has already announced plans to reduce VAT on electricity bills starting in October and to cap bus fares at £2 for the entirety of 2027. Stephen Millard, Niesr's deputy director for macroeconomics, stated that while the Bank of England is responsible for meeting the inflation target, the government must make difficult choices regarding funding. He indicated that new support measures should be financed through higher taxes, potentially involving tax reform rather than solely increasing marginal rates, or through reductions in other areas of spending. Millard suggested examining the welfare bill and the triple lock on pensions as potential areas for savings. Other options mentioned include reforming council tax towards a land value tax system or removing certain VAT exemptions. He also noted that if these measures were insufficient, breaking a manifesto promise on income tax rates might be considered, although the current government has pledged not to increase taxes for working people.

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Economic Growth Projections

Despite the challenges, Niesr has revised its forecast for UK economic growth upwards for the current year, projecting a rise of 1.1%. This adjustment is based on recent data indicating stronger performance than initially anticipated. However, the think tank estimates that the UK economy has lost approximately £15 billion in GDP due to the energy shock originating from the Middle East.