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 Andrew Bailey, 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 Middle East.
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 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 (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 Sir Keir Starmer “has no backbone” as she added: “There is an alternative: cut spending, cut tax, back business. Get Britain working again.”
Ms Badenoch has also called on the chancellor to scrap so-called ‘green’ subsidies before considering a taxpayer-funded energy bailout. The Tories claim household electricity bills could be cut by 20 per cent with measures including axing carbon taxes on energy generation and new drilling in the North Sea.
Ms Badenoch said: “Rachel Reeves doesn’t understand that subsidising energy bills with borrowed money doesn’t solve the problem, it just shifts the cost onto taxpayers and fuels inflation.
“To bring bills down we need to cut the costs driving them up. That means scrapping Ed Miliband’s green taxes that have left British households paying some of the highest energy prices in the developed world.”
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’s 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 by 2029-30.
Iran-US war latest: Trump threatens to ‘obliterate’ Iran’s power plants
UK fury over Iran’s ‘reckless attacks’ after Tehran targets Diego Garcia base
Iran’s long-range missiles can reach European cities, Israel warns
Iran’s missiles are a threat to London, Israel warns after attack on Diego Garcia
Why is the US-UK Diego Garcia military base in the Chagos Islands a target for Iran?
Starmer says US strikes on Iran won’t be launched from Cyprus after row over UK bases
