£50bn jump in debt payments threatens recovery windfall

Sunak

The public finances face a £50bn hit from climbing debt interest costs over the next five years as resurgent inflation threatens to wipe out the benefits of a rebounding economy.

Economists warned that Rishi Sunak’s wriggle room for Budget giveaways will be limited by higher inflation and rising borrowing costs as markets brace for a string of interest rate hikes.

In official forecasts released alongside the Budget on Wednesday, the Office for Budget Responsibility is set to predict that borrowing will be far lower than expected in the year to March.

A faster recovery and spending undershoots will bolster the public finances but any boost will be partially offset by recent price pressures.

While higher inflation will raise tax revenue and lower spending, helping to lower borrowing as nominal GDP rises, it also increases debt servicing costs.

“The higher debt service spending reduces the Chancellor’s room for manoeuvre going forward, particularly in conjunction with the new borrowing rules he is set to announce,” said HSBC economist Elizabeth Martin.

The bank predicted the OBR will forecast that additional spending on debt servicing will amount to £52bn over the next five years.

However, they warned the true cost should be £75bn as the watchdog’s figures were calculated before further rises in gilt yields and inflationary pressures. But the higher servicing cost will also be offset by stronger growth estimates since the OBR’s September 24 cutoff date.

Ms Martin said: “If the forecast included market moves through October, the rise in debt servicing costs would have been even bigger. So we expect the Chancellor to announce only small scale policy giveaways this year – centred on support for households and companies, and the climate change agenda.”

The Institute for Fiscal Studies expects borrowing for 2021/22 to be £180bn, more than £50bn lower than the OBR’s March forecast. It estimates that debt interest spending will be £15bn a year higher than previously expected.

Deutsche Bank economist Sanjay Raja said that the Chancellor will be given a “sizeable windfall” in the borrowing forecasts but warned that an economic slowdown or “persistent excess inflation could wipe away some of the gains accrued so far this fiscal year”.

The UK’s debt pile has risen to 96pc of GDP during the pandemic with around a quarter in inflation-linked gilts.

Markets expect the Bank of England to hike interest rates next month to stop prices running out of control. Investors are then bracing for a string of rate rises in 2022 that take the Bank’s base rate to above 1pc.

The Bank’s new chief economist Huw Pill warned that inflation is set to climb “close to or even slightly above 5pc” in early 2022.

He said an interest rate rise at November’s meeting is “live” amid a surge in market expectations in recent weeks fuelled by comments by Bank rate-setters.