The impact of Brexit on next week’s budget has been spelled out by one of Britain’s leading economic forecasters, with the difference between a soft and no-deal outcome worth around £15bn over the next five years for Philip Hammond.

According to the National Institute of Economic and Social Research (NIESR), the chancellor could increase spending on public services above and beyond the £20bn promised for the NHS - but only if Britain retains the closest possible relationship with the EU following its departure.

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It warned that a no-deal Brexit would erode almost all of this extra spending firepower and cause public borrowing to rise, while also warning that the pound would fall in value, inflation would rise and the economy would barely grow for two years.

The stark difference for the public finances from a deal or no-deal Brexit is likely to become an increasingly important political battleground over the coming months, and could feature heavily at the budget on Monday.

Although Theresa May pledged to “end austerity” in her speech to the Conservative party conference this month, she warned that the government would need to secure a “good Brexit deal” before it would be able to outline its approach to tax and spending next year.

Attaching the prospect of greater public spending to her version of Brexit could help the prime minister to win the votes she needs from MPs – particularly on the Labour benches – when parliament votes on the final plan for Britain’s withdrawal from the EU.

May must however first reach a deal with Brussels, which has so far proved elusive, with both sides currently at an impasse.

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Presenting the choices for the public finances, NIESR said: “Conditional on a soft Brexit, there is room in the government’s near-term debt and deficit targets to raise expenditure in areas where pressures are particularly high.

“By contrast, a no-deal Brexit would eliminate any fiscal space and require the government to stabilise the economy in the short term.”

In its analysis, NIESR said a soft Brexit deal would constitute the UK retaining access to the European Economic Area and customs union. Free movement of workers and EU budget payments would be maintained, which is likely to face stiff political opposition.

Reversing Brexit would have the potential to lift the cloud of economic uncertainty over Britain “immediately”, it added, while a no-deal scenario under which the UK trades with the EU on World Trade Organisation rules would trigger slower economic growth.

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Compared with a soft Brexit scenario, no-deal would cause annual output to be about 5.3% smaller over 10 years. UK economic growth would only be 0.3% in both 2019 and 2020, compared with 1.9% and 1.6% in a soft-Brexit scenario.

NIESR said the chancellor could increase spending by the £30bn in its forecast over the next five years without breaking his self-imposed fiscal mandate to keep the deficit within 2% of GDP by 2020-21, while also making sure that debt as a percentage of the overall economy would continue to fall.

The public finances have performed better than expected this year, driven by lower central government spending and less net borrowing by local authorities. Borrowing in the current financial year, which began in April, is about £10.7bn lower than at the same point a year ago, making 2018-19 so far the best year for the public finances since 2002.

Hammond would however be required to ditch his longer-term target to generate a budget surplus by the middle of the next decade under the NIESR forecasts, which it said was arbitrary and made little economic sense to maintain.

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Jagjit Chadha, the director of NIESR, said that should the government “continue to try and hit arbitrary fiscal rules” it would generate “suboptimal arrangements” in society.

“So much of debate on fiscal policy has been framed by the self-imposed rules of the chancellor. The regret is that it hasn’t focused on the true objective of fiscal policy … to find ways of sharing risk with previous and future generations,” he said.

• This article was amended on 26 October 2018. An earlier version said the difference between a soft and no-deal Brexit would be worth £30bn. That was based on figures released by NIESR. After publication, NIESR contacted us to clarify that figure is “around £15bn”, and has updated its press release accordingly. This has been corrected.