Tax cuts less likely in Budget due to surprise inflation rise, say insiders

A surprise increase in inflation could make it harder for Jeremy Hunt to cut taxes at the Budget, Government insiders fear.

Figures released on Wednesday revealed that the rate of inflation ticked upwards to 4 per cent in December, rather than falling as had been expected.

The reversal is likely to come as a blow to the Government’s ambitions to cut taxes again after a reduction in national insurance which took effect last week.

The Chancellor and Prime Minister have both dropped heavy hints that they want to go further at the Budget in March, boosting the spending power of voters ahead of the general election.

The Treasury has not yet received the first draft of updated economic and fiscal forecasts from the Office for Budget Responsibility (OBR), which will indicate whether Mr Hunt has “headroom” to cut taxes without breaking his own fiscal rules.

A senior Government source said that the rate of inflation was “still a concern” in light of the unexpected increase last month, adding: “Any fiscal loosening that risks fuelling inflation, we won’t do.”

Mr Hunt said: “As we have seen in the US, France and Germany, inflation does not fall in a straight line, but our plan is working and we should stick to it. We took difficult decisions to control borrowing and are now turning a corner, so we need to stay the course we have set out, including boosting growth with more competitive tax levels.”

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The increase from 3.9 per cent to 4 per cent was driven by a large rise in the price of alcohol and tobacco, the Office for National Statistics said.

The London stock market fell after the data was released as traders downgraded the chance of an imminent cut in interest rates by the Bank of England. Most economists still expect inflation to fall over the spring, reaching its target of 2 per cent by the end of this year.

The Chancellor has repeatedly insisted he will not enact policies that push up inflation by increasing the amount of money in the economy, such as unfunded tax cuts or inflation-busting rises in public-sector pay.

He has promised to use any further headroom in the public finances to reduce the tax burden rather than raising spending, despite warnings that public services face an unfeasibly tight financial settlement in the coming years.

It is unclear whether the OBR will increase the headroom in its updated forecasts, with recent economic developments pushing in multiple different directions.

Labour’s Shadow Chancellor, Rachel Reeves, said: “Any rise in inflation is bad news for families who are worse off after 14 years of economic failure. Prices are still rising in the shops, with the average weekly shop £110 more than it was before the last general election, and the average family set to be £1,200 worse off under Rishi Sunak’s tax plan.”