Inflation drives surge in interest payments on UK public debt

Interest payments on UK government debt hit one of the highest levels on record last month as rising inflation capped expectations for public sector borrowing.

Interest costs rose to £7.6bn in May, well above last year’s level and above the £5.1bn forecast by the Office for Budget Responsibility as retail prices rose rapidly inflation A lot of debt payments have something to do with it.

The ONS said debt interest payments were the third-highest monthly payment by the UK central government and the highest in any May on record.

Inflation has boosted the government’s borrowing costs, as gilts, indexed to retail prices, account for 25% of the UK government’s debt.

Official data on Wednesday showed the RPI rose at an annual rate of 11.7% in May, the fastest pace since December 1981.

Still, net borrowing by the public sector fell in May – but less than expected – as inflation also helped government finances by bringing in higher tax revenues.

Borrowing was £14bn in May, down £4bn from a year earlier, according to figures released by the Office for National Statistics on Thursday. But May’s borrowing was higher than the 12 billion pounds forecast by economists polled by Reuters, and well above the 10.3 billion pounds expected by the OBR.

A strong labor market and the reopening of the economy also boosted government revenue. Government revenue rose by £5.7bn in May, with tax revenue rising by £3.4bn a year.

Samuel Tombs, an economist at Pantheon Macroeconomics, pointed out that even government revenue fell short of the OBR’s forecast, especially GST revenue. That could indicate that “the economy is underperforming the OBR’s expectations,” he said.

Borrowings for April were also revised up. That meant a “disappointing start” to public finances for the financial year, said Martin Baker, chief economic adviser at the Ernst & Young Project Club.

Prime Minister Rishi Sunak said: “Rising inflation and rising interest costs on debt pose challenges to public finances, just as they do to household budgets.”

“Being responsible for public finances now means future generations will not have a higher debt service burden and we can secure our economy for the long term,” he added.

The end of most Covid-19 government support packages also partially offset higher interest expenses.

Line graph in billions of pounds, rolling 6-month average, showing an increase in central government interest payments on debt

Public sector net debt or long-term accumulated borrowing was 95.8 percent of GDP, the highest ratio since the early 1960s.

This year’s borrowing figures do not include a £15bn package of measures announced by the government last month to support households with soaring energy bills.

Michal Stelmach, senior UK economist at KPMG, said “the pace of deficit reduction will slow in the coming months” due to the government’s latest support package and weak economic growth. “Debt reduction this year is still a long way off,” he added.

Baker echoed: “Revenue growth is likely to come under increasing pressure from slower activity.”

Official data show the economy has stalled since January.

Tombs estimates total public borrowing will hit £130bn this year, well above the £99bn forecast by the OBR. Still, he predicted Sunak would start cutting taxes next year “to improve his party’s re-election chances”.

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