Rachel Reeves has been urged not to raise taxes in response to the economic shock brought on by the US’s war with Iran.
Ministers will next week hold an emergency meeting with the governor of the Bank of England to discuss plans to help households with the soaring cost of living caused by the conflict.
The average annual household energy bill alone is predicted to rise by £332 in July, according to the latest forecast from Cornwall Insights and experts have warned that further rises in the price of petrol and diesel are inevitable after attacks on energy infrastructure in the region.
There are also fears it could push up inflation, which could impact interest rates and prompt a rise in mortgage rates.
Economists have warned that all this means there is a growing risk Ms Reeves will be forced to either abandon her “iron-clad” borrowing rules or raise taxes.
Martin Beck, chief economist at WPI Strategy, told the Telegraph: “The risk is that an energy shock, even one that isn’t long-lasting, could leave the UK with higher underlying inflation, higher interest rates, weaker real incomes, lower investment and a smaller economy and tax base by 2029-30.
“If that happens, the chancellor may need tax rises or spending restraint later to restore compliance with the fiscal rules.”
Paul Johnson, former director of the highly respected economic think tank the Institute for Fiscal Studies, said Ms Reeves may be forced to relax her fiscal rules to avoid tax rises.
Mr Johnson said: “They may end up needing to be flexible on their fiscal rules, because this is the kind of situation in which you may not want to be increasing taxes or cutting spending in order to keep borrowing down.”
In response, Conservative leader Kemi Badenoch posted on X, formerly Twitter: “Labour’s answer to the ‘worst energy shock in history’? Higher taxes. Families already pay too much.”
She accused Labour of being “weak abroad. Weak at home” and said Keir Starmer “has no backbone” as she added: “There is an alternative: cut spending, cut tax, back business. Get Britain working again.”
Last week, Ms Reeves confirmed that she has set aside funding to support households reliant on heating oil, the cost of which had doubled in recent weeks, as well as “working through” a longer-term strategy to support other households once the energy price cap lifts in June.
“We’ve got some time, and we are working through in the Iran response board (a group of Treasury ministers and officials) different approaches that we could take, including looking at more targeted options,” she said.
Ms Reeves also expressed concern over the nation’s “high debt” and played down the likelihood of a broad energy bailout, similar to the £35bn package following Russia’s invasion of Ukraine.
Ms Reeves’ fiscal rules prevent her from borrowing to pay for day-to-day spending, and require debt to fall as a percentage of Gross Domestic Product (GDP) by 2029/30.
