UK debt interest bill to hit £500bn

High inflation and high interest rates will push the cost of servicing the government’s mountain of debt to more than £500bn over the next five years.

The scale of debt exposes the true cost to taxpayers of a decades-long borrowing spree, according to This is Money’s sister title, the Mail on Sunday.

Interest payments as a percentage of economic activity are the highest since the late 1940s, when the country faced the crippling costs of World War II.

This year alone, the interest bill is equivalent to more than £4,000 per household. It has raised fears that government spending — including on schools and health care — will need to be cut to balance the books.

The debt interest is to be paid to British and foreign investors who have lent money to the British government.

But it represents billions of pounds that could be used more productively, fund tax cuts or improve public services.

The annual interest payment is already equal to the combined spending on education and defense.

Experts say this massive debt burden will exceed that of Italy – one of the most indebted countries in Europe – and much higher pro rata than that of the US or Japan, based on recent data from the European Commission.

“It’s an astonishingly high number,” says Stefan Koopman, senior macro strategist at investment bank Rabobank.

“Having to put down that much to pay off the cost of existing debt will displace a lot of spending on public services and investment.”

In its March forecast, the Office for Budget Responsibility estimated that interest payments on government debt would peak at £115 billion this year. At that stage, the watchdog forecast £434bn in interest charges over the next five years.

But the debt burden – the cost of paying the country’s £2.6 trillion in loans – will now be much higher. This is because a large part of it is linked to inflation.

Interest rates have also skyrocketed, further driving up the cost of servicing the government’s growing mountain of debt.

The Bank of England raised its key interest rate from 4.5 percent to 5 percent last week.

Traders are betting it could rise to 6.25 percent early next year.

“Higher interest costs and inflation will add about £20 billion a year to the Chancellor’s annual bill,” said Sanjay Raja, British economist at investment bank Deutsche. That would bring this year’s bill to £114 billion (see table below).

“This will drive up the interest cost of the national debt to more than £100bn a year over the next five years,” he added.

He also warned Chancellor Jeremy Hunt would have “very little breathing room to increase spending.”

In his spring budget, Hunt promised to comply with the “fiscal rule” he had set for himself: that debt should decrease in five years in proportion to the size of the economy.

He had hoped to hit his target with £6.5bn left – while delaying government spending cuts until after the next election, which is due in 18 months.

But government borrowing now exceeds the country’s total annual economic output, partly because of higher interest costs. This is the first time since 1961 that debt has exceeded gross domestic product, and it gives Hunt little room for maneuver.

“With less than a year and a half left until the next general election, calls are mounting for the Chancellor to cut a series of taxes,” said Ruth Gregory of Capital Economics consultancy.

But she said the recent developments meant it was unlikely he would have much room for giveaways without jeopardizing his fiscal reign.

Interest payments on debt would rise by a “massive” £23bn this year alone, she estimated, bringing the total to £117bn – even higher than Deutsche’s forecast – or more than £4,100 per household.

According to Samuel Tombs of Pantheon Macroeconomics, the interest bill will be just as large in 2024-25.

More than one-fifth of government borrowing is tied to the Retail Prices Index historical inflation measure.

It currently stands at 11.3 percent, even higher than the consumer price index’s overall inflation rate of 8.7 percent.