UK budget watchdog will factor stickier inflation into next forecasts

By David Milliken

LONDON, June 2 (Reuters) - Britain's budget watchdog said on Tuesday it will factor in the unexpectedly strong persistence of inflation after the 2022 energy price shock when it updates its forecasts later this year in the wake of the Iran war.

The comments suggest the watchdog may reduce its estimate of the government's fiscal buffer by more than some analysts have predicted.

The Office for Budget Responsibility's forecasts determine how much leeway British governments have for public spending and get close attention from financial markets and politicians, as well as setting out forecasts for growth and inflation.

The last set, released on March 3, showed finance minister Rachel Reeves had a modest £24 billion ($32 billion) of 'headroom' to meet her goal of a balanced budget, excluding investment spending, by 2029-30.

But the figures did not take into account the impact of the Iran war which started on February 28 and which has led the Bank of England to forecast higher inflation and weaker growth.

In an annual assessment of its past forecasts, the OBR said it would take lessons from the 2022 energy shock after Russia's full-scale invasion of Ukraine into account when it prepares fresh forecasts for Reeves' annual budget later this year.

"We have adjusted our analytical and modelling toolkit, including our assumption for the second-round pass-through of energy prices to inflation and some of our short-term inflation modelling," it said.

The last energy shock led to higher inflation, more public spending and greater government borrowing and debt than the OBR forecast both at the time and in the years after.

Reeves has said that - unlike under the Conservative government in 2022 - she does not plan to offer costly universal energy subsidies.

The BoE has also said there are some reasons to expect inflation to be less persistent than in 2022 as the economy has more slack and natural gas prices have risen less.

($1 = 0.7426 pounds)

(Reporting by David Milliken; editing by William James)