The Office for Budget Responsibility’s own calculations on the impact of a war in the Middle East suggest that Rachel Reeves is set to oversee a surge in borrowing, City AM has found. Sir Keir Starmer and Reeves have said that the government’s focus on “stability” has added protections to
Mauricio Alencar
Wednesday 06 May 2026 4:00 am | Updated: Tuesday 05 May 2026 1:43 pm
The Office for Budget Responsibility’s own calculations on the impact of a war in the Middle East suggest that Rachel Reeves is set to oversee a surge in borrowing, City AM has found.
Sir Keir Starmer and Reeves have said that the government’s focus on “stability” has added protections to public finances and helped the UK economy suffer less severe effects from the war.
But the OBR’s own estimates, which determine whether Reeves has met her fiscal rules, suggest that steep tax rises or radical spending cuts will be needed later this year if the Chancellor wishes to avoid a sharp surge in borrowing over the coming years.
In 2024, the OBR estimated that the UK government would have to borrow an average of £23.1bn more a year if there were a cut to energy supplies “comparable to the 1973 oil embargo”. This analysis was conducted alongside the Budget amid concerns around a possible conflict between Israel and Iran at the time.
Economists have widely suggested that the current blockade on the Strait of Hormuz, triggered by the Iran war, is the worst global oil supply shock recorded in history. International Energy Agency chief Fatih Birol said last month it was more serious than supply shocks in “1973, 1979 and 2022 together”.
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Under the OBR’s assumption, oil and wholesale gas prices would remain 75 per cent higher over the course of a year. So far, oil prices have risen by 55 per cent and gas prices have risen by 40 per cent compared to January, when the fiscal watchdog last collected market data.
Reeves built in a headroom level of £23.6bn against the main fiscal rule to achieve a current budget surplus by 2030.
Matt Swannell, the chief economist at Item Club, suggested that some £10bn would be knocked off Reeves’ headroom against a rule to leave a surplus in the current budget by 2030. This includes the effects of higher interest payments baked in by moves across gilt yields.
He said that while the scenario analysis would mean the Chancellor meets her fiscal rules, the “narrowing wiggle room” left in public finances would bring discussions around the sustainability of fiscal measures back into the limelight.
Read more The tax effect: Reeves borrowed less than OBR forecast Spending demands loom over Reeves
Households and businesses are also awaiting details around an energy support package for those most in need. It is expected to come into effect no earlier than in the autumn, giving the Treasury some breathing time before drawing up a full proposal.
The fiscal framework stipulates that “temporary measures” that last fewer than two years do not require an assessment from the OBR.
The defence industry is also waiting on the full publication of the Defence Investment Plan, which should lay out some of the costing plans needed for the UK to spend 3.5 per cent of GDP on the armed forces and intelligence by 2035, as per a Nato agreement.
Together, public finances could face significant strains and leave the Chancellor having to make a major call on the security of the fiscal rules. The fiscal framework has a provision to allow the government to deviate from borrowing targets in the event of a “significant negative shock” to the UK economy.
City analysts believe it is increasingly likely that much of Reeves’ headroom has been erased by the war.
Higher tax receipts through windfall gains on gas and oil profits, plus extra intake on interest payments for government-funded loans and investments, could partly ease the pains.
There are also rumoured risks posed by local election results to Rachel Reeves’ tenure as Chancellor, with Tory leader Kemi Badenoch suggesting she would be reshuffled.
Reports have suggested that energy secretary Ed Miliband was being lined up as her successor after the local elections. Traders at top City firms have warned that bond markets could add to the risk premia on gilts, pushing up costs for the government, if Labour takes a leftward turn and fiscal policy is loosened.
The Treasury has been approached for comment.
Read more Labour peer tells Reeves not to use headroom as ‘piggy bank’ for spending
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