Faster growth to have limited impact on public debt, says UK fiscal watchdog - Financial Times

A rapid rebound in economic growth will do less to repair the UK’s public finances than in the past, because changes in interest rates will now feed through faster to government borrowing costs, the head of the fiscal watchdog has warned.

Richard Hughes, chair of the Office for Budget Responsibility, told the parliamentary Treasury committee on Wednesday that “even in the most benign scenario”, with real interest rates rising to reflect an improvement in economic activity, faster growth would make relatively little difference to the size of public debt over the medium term.

This is because government bonds carry shorter maturities on average than before, and a higher proportion are linked to inflation.

“The grace period, where you’re getting higher tax receipts from higher growth, but the interest rates are taking longer to feed their way through . . . that’s a lot shorter,” Hughes said.

He added that the government would need to be “more alive to the factors that might drive interest rates higher” and nimbler in the way it managed spending.

Hughes spoke after the release of official data that showed public borrowing has fallen faster than the OBR expected in its March forecast, as reopening the economy has supported tax revenues and cut spending.

Public sector net borrowing was estimated at £22.8bn last month, the Office for National Statistics said, £5.5bn less than in June 2020, and short of the £25.2bn forecast by the OBR in March — though it was the second highest reading for June since monthly records began in 1993.

“The strong economic recovery is feeding through into lower government borrowing,” said Ruth Gregory, senior UK economist at Capital Economics, arguing that the economy would “do more of the job in ‘fixing’ the public finances” than a fiscal tightening.

However, the figures also showed interest payments on central government debt soaring to their highest level on record, following increases in the retail price index to which they are linked.

“The volatility of debt interest spending underscores its sensitivity, not just to inflation but also to interest rates, which can rapidly change the path of fiscal sustainability,” said Michal Stelmach, senior economist at KPMG UK.

Despite a broad-based improvement in tax receipts, public sector net debt stood at 99.7 per cent of gross domestic product at the end of June, the highest ratio since March 1961.

Chancellor Rishi Sunak said he was “proud of the unprecedented package of support” to jobs and businesses, but added it was “right that we ensure debt remains under control in the medium term”.

But the Institute for Fiscal Studies on Wednesday warned the rebound in growth would boost the public finances only in the short term.

In the medium term, the rising cost of servicing government debt, combined with long-term damage to the economy because of the pandemic, would leave the chancellor hard pressed to meet his target of keeping the current budget in balance, the IFS said, even before factoring in pressures on public services not yet budgeted for.

Hughes said the spending plans implied by the March Budget, assuming no ongoing pandemic-related spending after this fiscal year, seemed “a very risky proposition”.

There were pressures on health, education, transport and other areas of the public services that at present “they are effectively not budgeting for”, he said, also highlighting the need to rebuild fiscal firepower. “We don’t know where the next shock will come from.”

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Faster growth to have limited impact on public debt, says UK fiscal watchdog - Financial Times
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