A quick recovery in economic growth will fix the UK’s public finances less than it has done in the past, as interest rate changes now impact government borrowing costs more quickly, the chief financial regulator warns.
Richard Hughes, chairman of the Office for Budget Responsibility, told the parliamentary finance committee on Wednesday that “even in the best scenario” with real interest rates rising due to an improvement in economic activity, faster growth would have relatively little effect on national debt levels in the medium term.
This is due to the fact that government bonds, on average, have shorter maturities than before and a higher proportion is linked to inflation.
“The transition period in which you generate higher tax income through higher growth, but it takes longer for interest rates to prevail. . . that’s a lot shorter, ”said Hughes.
He added that the government “needs to be more aware of the factors that could drive interest rates high” and to be more nimble in managing spending.
Hughes spoke after the release of official data showing that public borrowing has declined faster than the OBR expected in its March forecast as the reopening of the economy helped tax revenue and cut spending.
Net public sector borrowing was estimated at £ 22.8 billion last month, the Bureau of National Statistics said, down £ 5.5 billion from June 2020 and less than the OBR forecast 25.2 in March GBP billion – although this was the second highest for June since monthly records began in 1993.
“The strong economic recovery is translating into lower public debt,” said Ruth Gregory, UK chief economist at Capital Economics, arguing that the economy “would do more of a job of ‘fixing’ public finances” than it would if it were to tighten the budget.
However, the numbers also showed that interest payments on government debt rose to their highest level on record after the rise in the retail price index to which they are linked.
“The volatility of debt interest expenditure underscores its sensitivity, not only to inflation, but also to interest rates, which can quickly change the path of fiscal sustainability,” said Michal Stelmach, senior economist at KPMG UK.
Despite a broad improvement in tax revenues, the public sector’s net debt at the end of June was 99.7 percent of gross domestic product, its highest level since March 1961.
Chancellor Rishi Sunak said he was “proud of the unprecedented support package” for jobs and businesses, but added that it was “right that we ensure that debt remains under control over the medium term”.
However, the Institute of Fiscal Studies warned on Wednesday that the recovery in growth would only boost public finances for a short period of time.
In the medium term, the rising cost of servicing the national debt combined with the long-term damage to the economy from the pandemic would put heavy pressure on the chancellor to achieve his goal of keeping the current budget in balance, the IFS said even before the pressure was on public services that are not yet budgeted are taken into account.
Hughes said the spending plans implied in the March budget, assuming there will be no ongoing pandemic-related spending after this fiscal year, were “a very risky proposition”.
There is pressure on health, education, transport and other areas of public services that they are currently “effectively not budgeting for,” he said, also stressing the need to rebuild fiscal firepower. “We don’t know where the next shock will come from.”