Chancellor John Healey faces a potential £35 billion gap in public finances as he prepares his first Budget, the Institute for Fiscal Studies (IFS) has warned.

The influential think tank said that if the government wants to raise defence spending to 3% of national income by 2030 and increase health spending without squeezing other departments, it will need a significant financial "top-up."

Higher inflation, driven in part by the conflict in the Middle East, could erode the value of departmental cash budgets, forcing Healey to choose between spending cuts, tax rises, or a combination of both.

The Budget is scheduled for 28 October. The Treasury declined to comment.

IFS director Helen Miller said the chancellor had inherited spending plans that were already under strain before the latest inflationary pressures emerged.

"A 'steady-as-she-goes' Budget is not an option available to the chancellor," Miller said. "Choosing to stay the course with the inherited tax and spending plans would mean allowing inflation to blow departments' spending plans off course."

She added: "Simply pencilling in implicit cuts that he has no intention of delivering would make the Budget a work of fiction."

Miller told a broadcaster's morning programme that Healey had inherited plans under which departmental spending growth was already set to slow in the coming years.

"[It] already looked likely that he would have to make spending cuts just to live within those," she said. "Now, along comes the Middle East war, inflation goes up and those spending plans look very tight indeed."

The chancellor has also committed to raising defence spending to 3% of national income. Under Prime Minister Keir Starmer's leadership, Healey resigned as defence secretary in June following a dispute with the Treasury over military spending.

Miller said: "You put all that together, if he wanted to do all of that within current spending plans he's looking at having to cut some other services by something like £35bn."

She added that raising taxes to avoid departmental cuts while also funding higher defence spending would be difficult. "You'd really have to be scraping around and doing lots of small things to get up to big sums," she said.

The government is under growing pressure to demonstrate to financial markets that it has a firm grip on public finances, as borrowing costs continue to rise.

Speaking ahead of the annual International Monetary Fund meeting, Healey acknowledged the global impact of ongoing conflicts.

"The consequences of conflict in the Middle East and Europe are hitting countries worldwide, leading to higher prices at the pumps and more expensive mortgages at home," he said. "But Britain and our allies can face up to these challenges together."

He said his Budget "will build on this approach with fiscal discipline helping to deliver economic resilience" and give people "breathing space."

The wars in the Middle East and Ukraine have together contributed to higher energy prices globally, with increased costs passed on to consumers through higher prices on shelves and at the pumps. They have also contributed to a rise in UK government debt interest payments.

The IFS estimates that recent turbulence on bond markets and higher inflation will add around £10 billion to forecasts for government borrowing costs in 2029-30.

Despite this, the think tank still expects the government to meet its self-imposed fiscal rules — borrowing only for investment by 2029-30 and reducing debt as a share of GDP — partly because higher inflation also boosts tax revenues.

However, the IFS expects those rules to be met with a smaller buffer, or "headroom," of around £20 billion. That is less than the £24 billion buffer predicted at the time of the Spring Statement by the Office for Budget Responsibility.

The IFS also expects any household "breathing space" measures to be temporary and limited in scale.

Meanwhile, the government faces constraints on the tax side. Former chancellor Rachel Reeves announced billions of pounds in tax rises, while Labour pledged in its manifesto not to increase taxes on working people, ruling out rises to National Insurance, income tax, or VAT. Prime Minister Andy Burnham has said he will honour that commitment.