Inflation and mortgage rates elevated by Chancellor’s spending plans, says OBR

Inflation and mortgage costs are on track to be higher than previously expected due to the Chancellor’s spending and borrowing plans, according to the fiscal watchdog.

Chancellor Rachel Reeves announced almost £70 billion of extra spending each year, funded by business-focused tax hikes and additional borrowing, in her maiden autumn Budget.

The Office for Budget Responsibility (OBR) said the sharp increase in spending will contribute to higher inflation in the short-term, although it will also help drive stronger economic growth.

OBR member David Miles said: “The inflation profile is a bit higher than it would have been if there hadn’t been quite a substantial increase in spending.”

Inflation is set to stay above the Bank of England’s target of 2% until 2029, according to the latest forecasts, which upgraded their predictions for the next four years.

This means inflation is predicted to average 2.5% this year and 2.6% next year.

The official forecaster said that inflation would then come down, assuming “the Bank of England responds” to help bring it to the target rate.

The Bank of England has used higher interest rates in recent years to help bring down the rate of UK inflation after it soared to 11.1% in 2022.

The interest rate, which helps to dictate mortgage rates, currently sits a 5% after most recently being reduced in August by Bank policymakers.

Mr Miles said the OBR’s new inflation forecasts and borrowing projections – predicting the Chancellor will increase borrowing by £32 billion a year – mean interest rates are likely to be 0.25 percentage points higher than they otherwise would have been in the coming years.

As a result, the yield on UK Government bonds, also known as gilts, rose by around 2% following the announcement of the Budget.

Average mortgage rates are expected to rise from an average of 3.7% to 4.5% over the next three years, slightly above previous projections, according to the OBR.

It came as the forecaster also said the UK economy is set to grow more than expected this year and next year partly due to a boost from the Budget, although tax measures could dent its longer-term projections.

The OBR has predicted that UK gross domestic product (GDP) will grow by 1.1% in 2024.

This reflects an upgrade on its previous forecast of 0.8% and is stronger than recent projections by the Organisation for Economic Co-operation and Development (OECD) and International Monetary Fund (IMF).

The UK economy is also on track to grow by 2% next year, before a previously-predicted rise of 1.9%.

The OBR said that the fresh set of Budget policies, which will see spending increase by almost £70 billion each year, will “deliver a temporary boost to GDP”.

However, it said this positive impact will “fade to zero” within the next five years.

New forecasts also showed the economy is expected to grow by 1.8% in 2026, 1.5% in 2027 and 1.5% again in 2028.

This represents a downgrade in expected economic growth, with the forecaster having pointed towards 2% growth for 2026, 1.8% growth for 2027 and 1.7% growth for 2028 in the previous government’s spring budget statement.

It came as Ms Reeves announced a £40 billion increase in taxes, including a £25 billion raid on employers’ national insurance contributions and a rise in capital gains tax.

The OBR said tax increases would partly lead to “crowding out” of business investment, which would have 0.2% negative impact on economic growth in the medium-term.

The forecaster also said the latest financial policy measures are set to leave the Government with a buffer of £9.9 billion to balance the state finances by 2029/30.

This is significantly less than the £28 billion average headroom for previous chancellors and would not have been met were it not for new changes to its fiscal debt rules.

The fresh forecast also shows that UK inflation is set to be higher than expected for the next four years and remain above the Bank of England’s target rate.

Ms Reeves, delivering her first Budget, told Parliament on Wednesday that the forecaster has predicted that Consumer Prices Index (CPI) inflation will average 2.5% this year.

In its previous projections in March, the OBR pointed to 2.2% price growth for the year.

It comes despite inflation dropping to a three-year low of 1.7% in September after a sharp slump in petrol prices.

Ms Reeves also confirmed the Government will maintain the 2% inflation target rate for the Bank of England.

The central bank cut interest rates to 5% from a 16-year high of 5.25% in August, but higher-than-expected inflation could put pressure on expectations that borrowing costs will come down further quickly.

The latest OBR forecasts also indicate that inflation will rise to 2.6% in 2025 – significantly above the 1.5% rate previously predicted.

It also increased projections for the following three years, with inflation expected to hit 2.3% for 2026, 2.1% for 2027 and 2.1% for 2028.