Cost-of-Living Drive Faces Tough Choices as Inflation Threatens Longer Squeeze

Prime Minister Andy Burnham’s pledge to lead a “cost-of-living Government” has run into an immediate fiscal warning, with one of Britain’s leading economic think tanks arguing that new support must be funded through higher taxes or spending cuts rather than additional borrowing.

The National Institute of Economic and Social Research (NIESR) said the Government faced increasingly difficult choices as the economic consequences of the Iran war continued to feed through energy prices, inflation and the public finances.

Its latest forecast predicts that Consumer Prices Index inflation will average 3.1 per cent during 2026 and reach 3.8 per cent in February 2027. Inflation is not expected to return to the Bank of England’s 2 per cent target until early 2029 — a year later than previously forecast. NIESR

The prolonged squeeze has serious implications for households as well as food, retail and supply-chain businesses, which remain exposed to energy, transport and other operating costs.

NIESR also expects the Bank of England to keep interest rates at 3.75 per cent throughout this year and next, limiting the prospect of early relief for borrowers and businesses.

Burnham entered Downing Street last week promising to make household affordability a defining priority of his administration. The Government has subsequently pledged to remove VAT from electricity bills from October and hold bus fares at £2 throughout 2027.

However, NIESR deputy director for macroeconomics Stephen Millard questioned whether such measures addressed the underlying inflation problem and warned against financing them through debt.

“There’s clearly no scope for increasing borrowing, so it is about choices,” he said, according to The Independent.

Millard said the Government should consider tax reform or reductions in spending elsewhere, with the detail expected to become clearer when Chancellor John Healey delivers the Budget in October.

Potential options identified by the economist included changes to welfare spending, reform of the pension triple lock and replacing the existing council tax system with one based more closely on land values. He also suggested reviewing VAT exemptions and, if those measures proved insufficient, reconsidering the commitment not to increase income tax rates.

Burnham has said he intends to maintain Labour’s promise not to raise taxes on working people.

The Government must also reconcile its cost-of-living programme with its commitment to lift defence spending to 3.5 per cent of gross domestic product by 2035. Burnham said he and the Chancellor were working to ensure that the defence plan was fully funded before the autumn Budget.

There was some brighter news in NIESR’s assessment. The think tank increased its forecast for UK economic growth this year from 0.9 per cent to 1.1 per cent after recent data proved stronger than expected.

Nevertheless, it estimated that the Middle East energy shock had already cost the British economy approximately £15 billion in lost GDP.

The forecast leaves ministers confronting an uncomfortable balancing act: delivering visible relief to households while inflation remains stubbornly above target, borrowing capacity is constrained and major spending commitments continue to compete for limited public money.