City comment: Inflation adds to Rishi Sunak’s debt headache

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NS

Borrowing is slowly coming under control but there is another ghost on the horizon for government finance: inflation.

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This morning’s public sector financial data shows lending is slowly coming down from sky-high levels. The Treasury borrowed £18.8 billion in October, a historically high but £200 million low at the same level last year. The end of the furlough means that the number should start reducing further.

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But as borrowings decrease, the cost of debt continues to rise. Repayments have risen more than 200 percent over the past year to £5.6 billion, driven primarily by inflation. About a quarter of UK government bonds are linked to the Retail Price Index (RPI), a measure of inflation. The RPI has risen to 6% from 1.4% at the start of the year and is set to climb even higher next year under forecasts of the Bank of England.

The bank still argues that the price increase will be temporary and should be reduced. But interest rates are set to rise, another headache for the government. The Office for Budget Responsibility says a 1% increase in rates would increase government debt costs by £20 billion. This is a big part of change.

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Optimists point out that UK debt servicing costs are nearing historic lows thanks to rock bottom interest rates. It could take years for the Bank of England to keep rates down to a more ‘normal’ level.

Still, it’s easy to see why Rishi Sunak is getting sweaty palms.

The chancellor sits on a 2.2 trillion pound of debt that may seem manageable now but could soon get out of hand. No wonder he wants to squeeze every penny into Whitehall.

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