OBR says Chancellor’s spending plans are driving up inflation and mortgage rates

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

Chancellor Rachel Reeves announced in her first autumn budget that she would spend almost £70bn of extra spending each year, financed by business-focused tax rises and additional borrowing.

The Office for Budget Responsibility (OBR) said the sharp increase in spending would contribute to higher inflation in the short term but would also help support stronger economic growth.

OBR member David Miles said: “The inflation profile is slightly higher than it would have been without a significant increase in spending.”

Inflation will remain above the Bank of England’s 2% target until 2029, according to the latest forecasts, which have raised their forecasts for the next four years.

This means that inflation will average 2.5% this year and 2.6% next year.

The official forecaster said inflation would then fall, assuming the Bank of England would react to help reach the target rate.

The Bank of England has used higher interest rates in recent years to help reduce the UK’s inflation rate, which is set to rise to 11.1 per cent in 2022.

The interest rate, which helps determine mortgage rates, currently stands at 5% after it was last cut by Bank policymakers in August.

Mr Miles said the OBR’s new inflation forecasts and borrowing forecasts – with the Chancellor predicting it would increase borrowing by £32bn a year – meant interest rates were likely to be 0.25 percentage points higher than they would be in 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.

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

It also comes after the forecaster said the UK economy will grow more than expected this year and next, thanks in part to support from the budget, but tax measures could hurt long-term forecasts.

The OBR predicts that the UK’s gross domestic product (GDP) will rise by 1.1% in 2024.

This reflects the previous estimate of an increase of 0.8% and is stronger than the latest forecasts from the Organization for Economic Co-operation and Development (OECD) and the International Monetary Fund (IMF).

The UK economy is also on track to grow 2% next year, ahead of the 1.9% growth previously forecast.

The OBR said the new set of Budget policies, which would see spending rise by almost £70bn each year, would “provide a temporary boost to GDP”.

But he said this positive impact “will drop to zero” within the next five years.

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

This represents a decline in expected economic growth; The forecaster had predicted growth of 2% for 2026, 1.8% for 2027 and 1.7% for 2028 in the previous government’s spring budget statement.

It comes after Ms Reeves announced a £40bn tax increase, which included a £25bn raid on employers’ national insurance contributions and an increase in capital gains tax.

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

The forecaster also said the latest fiscal policy measures would leave the Government with a buffer of £9.9 billion to stabilize state finances by 2029/30.

This is significantly less than the average £28bn gap allocated for previous chancellors and would not have been met without new changes to financial debt rules.

The new forecast also shows that inflation in the UK will be higher than expected for the next four years and will remain above the Bank of England’s target rate.

Delivering her first Budget, Ms Reeves told Parliament on Wednesday that forecasters predicted Consumer Price Index (CPI) inflation would average 2.5% this year.

The OBR had pointed to a 2.2% price increase for the year in its previous forecasts in March.

This comes despite inflation falling to a three-year low of 1.7% in September following a sharp fall in oil prices.

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

The central bank cut interest rates to 5% in August from 5.25%, a 16-year high, but higher-than-expected inflation could weigh on expectations that borrowing costs will fall rapidly.

The latest OBR forecasts also show inflation will rise to 2.6% in 2025, well above the previously forecast rate of 1.5%.

In addition, forecasts for the next three years have been increased, with inflation expected to reach 2.3% for 2026, 2.1% for 2027 and 2.1% for 2028.