Hopes of tax cuts dwindle as UK debt rates soar

Economists have warned that Britain’s soaring debt interest bill will wipe out any fleeting prospect of significant tax cuts ahead of the election.

Hopes that Chancellor Jeremy Hunt might have leeway for big gifts grew last week as the national debt figures fell short of expectations.

However, rising interest rate expectations and higher yields on UK government bonds, known as gilts, suggest that the cost of servicing the government’s huge mountain of debt over the next five years could be up to £150 billion higher than previously thought, according to an analysis by Pantheon Macroeconomics .

Such a sharp rise in borrowing costs would wipe out Hunt’s slim margin if he wants to meet his goal of reducing debt as a percentage of economic output over the next five years. Sticking to this plan is the key to calming the financial markets, say experts.

Under pressure: Prime Minister Rishi Sunak and Chancellor Jeremy Hunt

“The turmoil following last autumn’s mini-budget suggests markets are likely to be less willing to tolerate plans that lack credibility, particularly given the economic backdrop,” said Samuel Tombs, the Pantheon’s chief UK economist. “We are confident that the Chancellor will not announce any significant tax cuts this year.”

The sober analysis is likely to dampen tax cut hopes sparked by last week’s better-than-expected public sector financials.

They showed that the national debt was £56.6 billion in the first four months of the financial year – April to July. That’s £11.3 billion less than the Office for Budget Responsibility, the financial regulator, expected in March.

But there were also unwanted surprises in the details. Public sector collective bargaining increased spending as the government sought to end damaging strikes.

And interest payments on the government’s £2.6 trillion debt were higher than expected. That’s partly because the interest rate on some of the debt is indexed to inflation, which hasn’t come down as quickly as hoped. This means that spending on debt interest was £37.8bn in the financial year to date – £1.9bn more than the OBR had expected in March.

Expenditure on debt interest was nearly £107bn last year and is expected to still reach a staggering £94bn this financial year.

Overall, the picture for public finances looks healthier this year than before, but the longer-term picture is more worrying. Tombs said that based on the latest data, the OBR will have to revise its forecast for debt interest payments each of the next five years.

He said it would need to be increased by around £40bn over the next financial year (2024-25) and £20bn in five years, with the total increasing by £150bn over five years.

The worse-than-expected outlook is challenging for Hunt as the OBR believes he has just £6.5billion of fiscal space to meet his debt target. This is the smallest margin since the regulator was introduced 13 years ago.

Capital Economics’ Ruth Gregory said, “We believe Hunt will have little leeway to announce large, permanent tax cuts and/or spending increases in the fall statement without jeopardizing its fiscal rules.”

He is under pressure to abolish tourist and inheritance taxes and lower corporate taxes. But he is understood to prefer stimulating growth through pension fund reform, freeing up £50bn of investment in UK technology and infrastructure.