Jeremy Hunt has enough headroom to cut taxes by at least another £10bn before the next election as borrowing costs fall.

Economists have said the Chancellor has been boosted by lower gilt yields and a hope that the Bank of England will start cutting interest rates by next summer.

That has fuelled predictions that Mr Hunt will have the option to cut income tax by a penny during his Spring Budget, driven by less being spent on Britain’s huge debt interest bill.

UK benchmark 10-year gilt yields fell below 4pc last week and have declined by roughly half a percent since Mr Hunt delivered his Autumn Statement in November.

Investors are also betting that interest rates set by Threadneedle Street will be closer to 3.5pc in five years, instead of 4pc.

Goldman Sachs said on Sunday that it expected Governor Andrew Bailey to announce the Bank’s first rate cut in August, with further reductions expected at every policy meeting until the middle of 2025.

Capital Economics said the falls would help to reduce Britain’s debt interest bill and increase the likelihood that Mr Hunt will meet his goal of falling debt by the end of the decade.

Ruth Gregory at Capital Economics, a former economist at the Office for Budget Responsibility (OBR), said: “Taken together, this might be expected to reduce borrowing by around £12bn by 2028-29. Public sector current receipts are about £1.2bn lower, but debt interest spending is reduced by about £13.8bn.

“Assuming the moves are sustained and all else is equal, we estimate the headroom could rise from £13bn against the Chancellor’s main fiscal rule to about £24.5bn, an increase of £11.5bn.”

Ms Gregory said Mr Hunt could afford to cut taxes by more than £10bn while maintaining some headroom. Cutting income tax by a penny would cost roughly £7bn a year while abolishing inheritance tax would cost about £8.4bn.

The Chancellor is also expected to cancel the 5p rise in fuel duty due next April, which will cost about £6bn a year.

Capital Economics believes the Treasury could enjoy an even bigger windfall in the March Budget if January pay deals are larger than expected.

Mr Gregory added: “If we are right, this would be consistent with an even bigger buffer of about £35bn against the Chancellor’s main fiscal rule.”

Higher inflation has forced workers to hand more of their pay rises to the taxman amid a six-year freeze in income tax thresholds, which has dragged people into higher tax bands.

The new forecasts come as the Bank of England prepares to keep interest rates at their current level of 5.25pc this week in the final meeting of the Monetary Policy Committee (MPC) this year.