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Before the financial crisis collapsed public finances and the economy in 2008-2009, Labor Chancellor Gordon Brown was keen to point out that his management of public finances helped drive interest rates on the national debt to negligible levels.
There was no mention of this volatile topic in Jeremy Hunt’s lengthy speech, but the numbers are explosive.
The Office for Budget Responsibility estimates that debt interest has more than doubled in the current fiscal year 2022-2023 to £120.4 billion, or 4.8 per cent of total output.
Pressure: The Office for Budget Responsibility estimates debt interest will more than double in the current fiscal year 2022-23 to £120.4bn or 4.8% of total output
To put that in context, it’s more than the 4.6 per cent of GDP shortfall on current expenditure and not far short of the £133bn the NHS gobbled up this year.
Since the turn of the century, the UK’s debt burden has become extremely sensitive to changes in interest rates and inflation.
Fortunately, the Bank of England was able to meet its 2 percent inflation mandate for most of the period.
The financial crisis, Covid and the Russian war on Ukraine have naturally inflated the cost of living and interest rate outlook
Total indebtedness quadrupled from 28 percent of output in 2000-2001 to an expected peak of 102 percent in the current fiscal year.
It is reassuring that, even at this level, the UK debt-to-GDP ratio is lower than that of Japan, the US, Italy and France.
Hard numbers are alarming, with a one percentage point rise in interest rates adding £26bn to the annual bill, up from just £6bn in the millennium.
One of the main reasons for this ratchet is the structure of the debt. In 2000-2001, only 6 percent of loans were linked to the retail price index, compared to 22 percent today.
Why indexed stocks are linked to selling prices (RPI) rather than the consumer price index (CPI) is inexplicable. RPI almost always runs hotter than CPI.
Quantitative easing has also fueled interest rates on debt. The use of this by the Bank has resulted in a shortening of the maturity of UK debt and this increases the impact of interest rate rises on a bill that ultimately rests with the taxpayer.
The use of indexed shares expanded as there were willing buyers in UK pension funds.
The failure of successive chancellors to keep a clear eye on the government bond market has undoubtedly been a car crash waiting to happen.
Former investment banker Harriet Baldwin MP, now chairman of the Treasury Select Committee, could make her mark by launching an investigation into how this disastrous mismanagement of public finances came about.
Finally free
Very good that the Treasury and the prudential arm of the Bank of England, in a last-minute deal, finally have an agreement that will free the UK from the onerous rules of Solvency II.
The great hope will be that this will free up the billions of pounds held by insurers and pension funds for investment in infrastructure.
The Prudential Regulation Authority supports the goal, but is also concerned about capital buffers.
That’s understandable, given that the financial system was on the verge of collapse when a sharp shift in government bond yields created chaos in the heavily liability-based investment market.
The move to Solvency II may not be so groundbreaking as it seems that some of the biggest players, such as Legal & General, have been investing carefully in infrastructure, housing projects and the like for several years now.
The Treasury seems to give with one hand and take with the other.
Limiting tax breaks on capital gains and estate taxes, freezing ISA allowances and lowering the taxpayer threshold of the highest rate are measures that dampen aspiration and encourage wealth to shift abroad.
Not a great policy in a country that craves investment.
Killing the dragon
Grant Shapps has shown guts by blocking the sale of British chipmaker Newport Wafer Fab to Nexperia, where Chinese investors have ultimate control.
It can be trusted that this marks a tougher stance against the export of valuable British technology to Beijing.
The finance minister should now look at the billion-dollar purchase of Aveva by the French Schneider, which has significant operations in China. Britain is too careless with its intellectual property.
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