Inflation and interest rate hikes to fuel government borrowing boom

A ‘triple-whammy’ on the public purse: Inflation and interest rate hikes to fuel government borrowing boom as Bank of England forecasts a recession

Red-hot inflation and rising interest rates will wreak havoc on the public purse, economists warned yesterday.

The rise in the cost of living will hit 13.3 per cent in October, the Bank of England predicted yesterday as it forecast a recession in the UK, which would drag on for over a year.

This will drive up the interest payments on the country’s towering £2.3 trillion debt mountain, a quarter of which is linked to the RPI (retail price index) measure of inflation.

The rise in the cost of living will hit 13.3% in October, the Bank of England predicted yesterday as it forecast a recession in the UK, which would drag on for over a year

The rise in the cost of living will hit 13.3% in October, the Bank of England predicted yesterday as it forecast a recession in the UK, which would drag on for over a year

At the same time efforts to bring down the soaring cost of living by hiking interest rates will also add to the new Chancellor’s woes. Combined with a shrinking economy, they will inflict a ‘triple-whammy’ on the public purse.

Officials at the Bank of England voted yesterday to hike interest rates by 0.5 percentage points –the largest lift in 27 years – in an attempt to get a grip on the cost-of-living crisis.

It is the sixth time the Bank has bumped up rates since last December, from their pandemic record low of 0.1 per cent, as it desperately grapples with rising inflation.

But a higher base rate of 1.75 per cent, levels last seen in late 2008, will drive up the cost of borrowing for the Government as well as ordinary Britons.

Paul Dales, chief UK economist at consultancy Capital Economics, said: ‘It’s a triple whammy. The rise in interest rates and the higher inflation forecast will mean that the Government’s borrowing costs are higher than otherwise. 

And then the recession means tax revenues will be lower than otherwise and benefit spending will be higher, so Government borrowing will be higher as a result.’

Dales was already predicting borrowing would be £110billion in 2022-23 versus the official Budget watchdog’s forecasts of £99billion. 

Even before yesterday’s bleak projections from the Bank, interest payments on the UK’s debt pile jumped to a record high of £19.4billion in June.

The worrying forecasts for the Exchequer come at a time when Tory leadership hopeful Liz Truss is promising tax cuts to boost growth. 

While the Office for Budget Responsibility previously forecast that the next Chancellor would have around £30billion of ‘wiggle room’ if they still wanted to meet their goal of hitting a budget surplus by 2025-26, that is now likely to be swallowed up by higher interest payments.

It will mean Truss will likely have to borrow more if she wants to knock some money off families’ tax bills.

Simon French, chief economist at investment bank Panmure Gordon said the Bank’s new forecasts would be ‘a disaster for tax cut plans if Truss wants to retain the same fiscal rules’ as former Chancellor Rishi Sunak. 

But he argued that he could see a justification for borrowing more to help struggling households in such exceptional circumstances, even if it did dent the public purse.

The Bank is predicting CPI inflation – which is usually a few percentage points lower than RPI – to hit 13.3 per cent in October.

This is far higher than the 11 per cent which Bank of England governor Andrew Bailey predicted two months ago. It would also be the highest level of inflation since September 1980.

The rise in the cost of living is set to remain high for much of next year, the Bank warned.

The damage this is inflicting on households means their spending will slump, tipping the country into a recession from the final quarter of this year. 

The downturn will last until the end of 2023, the Bank predicted, in a recession similar to the early 1990s.

Bank set to unwind QE life support

Bank of England Governor Andrew Bailey said he expected to reduce gilt holdings by around £80bn over the year

Bank of England Governor Andrew Bailey said he expected to reduce gilt holdings by around £80bn over the year

The Bank of England will begin to actively unwind its massive money-printing programme which pumped billions of pounds into the economy during Covid.

Officials on Threadneedle Street said that from September, subject to a final vote, they would start selling the vast pile of government bonds they had accumulated.

The quantitative easing (QE) programme was launched in the financial crisis, but revived during the pandemic.

It involved the Bank buying hundreds of billions of pounds of gilts – or debt loaned to the Government – from investors, freeing up more money for them to spend elsewhere in the economy.

But the Bank plans to sell those gilts back, tightening monetary policy in an attempt to bring inflation down from its 40-year highs. Governor Andrew Bailey said he expected to reduce gilt holdings by around £80bn over the year.

While this could help bring inflation down, it is likely to push up the cost of borrowing – the market will be awash with gilts, so their cost will fall, meaning the effective interest rate which they pay out will be higher.

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