Rocketing interest rates and inflation drove UK government debt above 100% of GDP for the first time since 1961, dealing a blow to Prime Minister Rishi Sunak’s pledge to get it falling and denting hopes for tax cuts in the build up to an expected general election next year.
(Bloomberg) — Rocketing interest rates and inflation drove UK government debt above 100% of GDP for the first time since 1961, dealing a blow to Prime Minister Rishi Sunak’s pledge to get it falling and denting hopes for tax cuts in the build up to an expected general election next year.
The bleak milestone was passed as spending exceeded revenue by £20 billion ($25.5 billion) in May, more than private-sector economists and the independent Office for Budget Responsibility had forecast.
It left the budget deficit in the first two months of the fiscal year at £42.9 billion – £2.1 billion more than the OBR projected and almost double the same point last year.
The figures make it hard for Sunak to deliver the big tax cuts many Conservatives say are needed if the party if to avoid a defeat at the next general election. Opinion polls show the Tories consistently trailing the opposition Labour Party by double digits.
The data from the Office for National Statistics showed the overshoot was driven almost exclusively by factors related to the inflation crisis, which has prompted the Bank of England to raise rates from 0.1% to 4.5% since the end of 2021.
Support for household energy bills in May cost £3.6 billion, and inflation-indexing of benefits added £2.9 billion to welfare spending.
Striking public-sector workers secured bigger pay deals than planned, with wage costs for May £3.4 billion higher than last year – largely due to the National Health Service settlement.
Debt-servicing costs, which have driven up spending as galloping inflation pushed up payments on bonds tied to the Retail Prices Index, were slightly lower than a year earlier at £7.7 billion. That was still £700 million more than the OBR forecast at the time of the March budget.
Spending overall was higher than forecast for May and, in a worrying sign for the growth outlook, reveipts were slightly below expectations.
The EY ITEM Club said borrowing this year is now likely to be £20 billion higher than the £132 billion predicted by the OBR. Unless the spike in market rates reverses, the government is likely to be “in breach of its fiscal rules,” the forecasting body said.
The government had just £6.5 billion of headroom against its rule that debt must be falling as a share of GDP by the fifth year of the forecast in its March budget. Every percentage point increase in borrowing costs adds around £20 billion and market rate projections are currently around 1% higher than in March.
Chancellor of the Exchequer Jeremy Hunt said: “It would be manifestly unfair to leave future generations with a tab they cannot repay. That’s why we have taken difficult but necessary decisions to balance the books in order to halve inflation this year, grow the economy and reduce debt.”
Ruth Gregory, deputy chief UK economist at Capital Economics, said the figures “cast further doubt on the chancellor’s ability to unveil big pre-election tax cuts while still meeting his fiscal rules” and that any giveaway “may be modest or swiftly reversed.”
Martin Beck, chief economic advisor to the EY ITEM Club, said a Conservative government was likely to pile on austerity in the years following the election, which must be held by January 2025 at the latest
“The chancellor would likely respond by adding more post-election spending cuts on top of a spending squeeze that already looks challenging. So the true medium-term path for fiscal policy is unlikely to emerge until the first Budget after the election,” he said.
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