The increase in interest rates paired with the rise of inflation are serious threats to public finances. This is due to the fact that the national debt is exposed to price fluctuations and the Office of Budget Responsibility has issued severe warnings.
The UK has £1.7 trillion in national debt, and much of this is in gilts that automatically alter with inflation. Another huge chunk is assigned to the Bank of England. This amount is particularly sensitive to changes in the interest rates and these usually follow inflation.
The link between debt and interest rates
Britain’s debt is generally considered low risk because the average maturity is 15 years, roughly twice other G7 countries’, which means it does not have to refinance as often. However, a fifth of all gilts automatically rise with the retail prices index of inflation. The £371 billion held by the Bank is highly sensitive to interest rate rises because the effective borrowing cost for the state is base rate, which is currently just 0.25 per cent. As a result, 45 per cent of the nation’s debt is particularly “vulnerable”, Robert Chote, chairman of the OBR, said. RPI has risen from 1.4 per cent to 3.7 per cent in the past year, largely due to sterling’s devaluation since Brexit. The OBR pointed to several other risks.
Leaving the European Union poses numerous threats. A decline in trade could hit productivity and, consequently, growth. Even at €75 billion, the divorce bill from the EU “would not pose a big threat to fiscal sustainability”, the OBR said, but “if GDP an
d receipts grew just 0.1 percentage points more slowly than projected over the next 50 years, but spending growth was unchanged, the debt-to-GDP would end up around 50 percentage points higher”. Lower migration could deplete the working population and leave debt as percentage of GDP 31 percentage points higher than currently forecast in 50 years’ time. Brexit could also deliver a further sterling devaluation, which would make the national debt more expensive by driving up inflation and rates.
Britain is due a recession soon. Since the 1970s there has been one every decade but the last was in 2009. “The risk of a recession is one in two over any five-year horizon,” the OBR said. A stress test that saw the economy shrink 4.7 per cent, not as much as in 2009, with 5 per cent inflation and 4 per cent interest rates, would add £596 billion to the national debt over the next five years. Debt would end up at 1.13 times the size of the economy in 2022, rather than the 0.8 times currently forecast.
The country’s ageing population and technological advances are putting pressure on health and care spending. The OBR is projecting spending to rise from 6.9 per cent of GDP in 2021 to 12.6 per cent of GDP in 2066. The office identified the risk as one of the biggest “slow building fiscal pressures” alongside persistently weak productivity growth.
Whilst there are many factors contributing to the continuous rise of the UK’s debt, surprisingly, many experts are suggesting there is little we can do as individuals to help. Reassuringly, it does seem that the overall debt of the nation is unlikely to affect citizens directly. Therefore, it should be each person’s priority to minimise their own debt and improve their own forecasts with minimal regarding to the country’s debt as a whole.