UBS Warns UK Fiscal Headroom on Track to Plummet £10 Billion

UK fiscal headroom is expected to be significantly lower than estimated by the Office for Budget Responsibility (OBR) in March, due to higher interest-rate and inflation assumptions. According to analysts at UBS, if the OBR sets its forecast cutoff date around Sept. 2, assumptions for the Bank of England's policy rate and 10-year gilt yields would be around 70 basis points higher than in March, reducing fiscal headroom by approximately £10 billion or 0.3% of GDP.

The OBR's migration and housing assumptions may also contribute to a narrower headroom, with UBS citing the Institute for Fiscal Studies as estimating that a downgrade to the migration assumption could reduce headroom by an additional £4 billion.

With the Labour government maintaining pledges not to raise income tax, VAT or corporation tax, potential revenue sources are limited. Chancellor Healey may accept a smaller but still positive headroom, and the government could seek greater flexibility within the fiscal rules, including channeling more public investment through public financial institutions.