Pre-Budget Briefing #2: Fiscal headroom and why it moves so much

Ahead of John Healey’s first Budget on the 28th of October we are publishing a series of briefings from our in-house experts to help organisations to understand the Budget process and the key factors influencing the Chancellor’s decisions. This post is written by Principal Economist Matt Latham.

When John Healey delivers his Budget, the figure many experts will look for is the headroom. It will be the first formal test of the government's fiscal rules since last November, with the OBR now only assessing them once a year.

What is ‘headroom’?

The government has two main fiscal rules, both judged in 2029-30. The first, the stability rule, requires the current budget to be in balance. Day-to-day spending must be covered by tax and other receipts, so the government borrows only to invest. The second, the investment rule, requires public sector net financial liabilities (essentially government debt net of financial assets) to be falling as a share of GDP by 2029-30.

Headroom is the margin by which the OBR expects each rule to be met. The stability rule has been the tighter of the two recently, so that's what people are really talking about when they say "the headroom."

In March the OBR put headroom against the stability rule at £23.6bn, up from £21.7bn at the November 2025 Budget. These sound like big numbers, but its worth noting that the numbers it's calculated from - receipts and day to day spending in 2029-30 - are each well over £1 trillion.

The size of those figures means that a 1% revision to either would move headroom by more than £10bn. Revisions of that size are normal. The IFS calculates that since 2010 the OBR's borrowing forecast for four years ahead has moved by 0.6% of GDP on average between forecasts, before any policy changes. That is about the same as the headroom left at the November 2025 Budget.

Why the headroom figure is so uncertain

The OBR's forecast for productivity growth drives its view of wages and profits, and therefore of tax receipts. Last November it cut its assumption for trend productivity growth by 0.3 percentage points a year, to 1%. On its own that would have reduced receipts in 2029-30 by about £16bn, around three quarters of the headroom the Chancellor ended up with.

Public sector net debt is around 95% of GDP, so small changes in interest rates also turn into large sums when it comes to the government's bills. The OBR has previously estimated that a one percentage point rise in interest rates adds up to £17bn to debt interest by the end of its forecast.

Interest rates have risen sharply since March. The war in Iran has pushed up energy prices and inflation, and markets have moved from expecting cuts in Bank Rate to expecting rises. Ten-year gilt yields reached about 5.2% in early September, their highest since 2008, as our first briefing set out. The 30-year yield went above 6% last week for the first time since 1998.

Most independent estimates now put headroom well below the spring figure: around £12bn to £14bn according to Deutsche Bank, KPMG and Bloomberg Economics, and below £8bn on the Resolution Foundation's numbers. These estimates come before any new tax or spending decisions.

The OBR does not use market rates on Budget day. It takes an average over a short window, usually ten working days, some weeks before the Budget. A sell-off or a rally during that window can move the headroom figure by several billion pounds with nothing having changed in the real economy.

What it means for the Chancellor

Healey has committed to meeting the fiscal rules with some headroom to spare. The possible forecast changes pointed to above could take several billion pounds off the margin before he announces a single policy. In principle a smaller margin can be closed by raising taxes or cutting spending. In practice almost every option is a minefield.

Labour's manifesto rules out increases in income tax, employee National Insurance, VAT and corporation tax, which together raise most of the government's revenue. The government has already raised taxes in both of its Budgets, and the business backlash against higher employer National Insurance in 2024 is still fresh. A third round would be harder still to defend.

Spending offers little more room. Unprotected departments have had more than a decade of tight settlements, and current plans already assume further savings. The fastest spending growth is in health, pensions and working-age welfare, where the government has struggled to find savings: it dropped much of its disability benefit reform in 2025 after a backbench rebellion.

Defence spending also has to rise. The IFS estimates that meeting the government's commitment of 3.5% of GDP by 2035 means finding around £25bn a year more than current plans, in today's money. Healey himself resigned as Defence Secretary over defence funding.

With so little room on either side, a downgrade of even £10bn would force choices the government has spent two years trying to avoid. Leaving a thinner buffer only defers the problem. Rachel Reeves left £9.9bn of headroom in October 2024. It had gone by the following spring and had to be rebuilt twice, through welfare cuts in March 2025 and tax rises in November 2025. Before November 2022 chancellors left around £33bn on average in today's terms, according to the IFS, compared with about £12bn since. Most of that earlier period was also calmer in geopolitical terms than the one Healey faces.

There is also a question over how much weight the UK puts on a single headroom figure. Witnesses to the Treasury Committee's inquiry into the OBR, which reported last month, argued that the focus on it makes fiscal policy volatile, with small forecast revisions forcing rushed changes to tax and spending. Ben Zaranko's proposal at the IFS would replace the pass/fail test with a set of fiscal traffic lights. Most witnesses, the IFS included, warned that changing the rules now could be read by markets as an attempt to borrow more. The UK already stands out for how often it changes them: the former OBR chair Richard Hughes told the committee that the average UK fiscal rule had lasted 1.8 years over the past decade.

A larger buffer would reduce the risk of forced corrections and might, over time, lower the premium investors demand to hold gilts, but delivering one requires the same tax rises or spending cuts that are already so hard to find.