Higher interest costs push UK public borrowing to twice expected level

Britain’s public finances have given new chancellor Kwasi Kwarteng a difficult backdrop for his mini Budget on Friday, with government borrowing rising to twice the level the independent fiscal watchdog had expected for August.

The figures and overnight indications from Prime Minister Liz Truss’s government that it wants to cut taxes further than expected this week raised fears that the package would prove unsustainable and require significantly higher interest rates.

Markets are concerned that a borrow and spend package when unemployment is at a 50-year low and inflationary pressure is already high will leave the UK living beyond its means and require the Bank of England to slam on the brakes.

The prospect of even higher interest rates did not bolster sterling against a very strong US dollar in early trading on Wednesday, with the pound slipping to another 37-year low of $1.132.

In August, the public sector borrowed £11.8bn, higher than City forecasts of £8.8bn and almost twice the amount estimated by the Office for Budget Responsibility earlier in the year. The fiscal watchdog thought the figure would be only £6bn.

With the chancellor set to unveil the costs of the government’s energy support package on Friday, financed by additional borrowing and large permanent tax cuts, the level of borrowing is expected to rise sharply above these estimates later in the year.

Kwarteng was unapologetic about the government’s new strategy. In a statement he said that strong growth and sustainable public finances went hand in hand.

“As chancellor, I have pledged to get debt down in the medium term. However, in the face of a major economic shock, it is absolutely right that the government takes action now to help families and businesses, just as we did during the pandemic,” he said.

Jens Larsen, a director at Eurasia Group, the consultancy, said that the government’s new strategy was likely to result in a decline in the popularity of UK assets in financial markets.

Column chart of Monthly difference between outturn and forecast (£bn) showing Public sector borrowing is slipping below OBR forecasts

“The combination of a potentially expensive and relatively inefficient fiscal package, a central bank intent on demonstrating its independence and a very large net supply of gilts will probably lead to continued upward pressure on UK risk premia,” Larsen said.

Loosening fiscal policy will put the Bank of England on the spot on Thursday when officials meet to decide how quickly to raise interest rates from the current 1.75 per cent. Financial markets expect rates to rise above 4 per cent by the summer of next year.

On the public finances, economists were certain that borrowing would rise significantly. Samuel Tombs, chief UK economist at Pantheon Macroeconomics, said that even excluding the energy package, “the new government’s fiscal activism” would leave public borrowing much higher than expected this year, with a deficit of £125bn compared with the OBR’s March forecast of £99.1bn.

Including the energy package, which is to be financed by borrowing and could amount to £150bn over two years, Capital Economics said the deficit was likely to be £165bn this year — representing 6.5 per cent of national income.

The data did not show that a slowdown in economic growth had not yet increasing borrowing, with central government tax receipts of £69.6bn only a little below the OBR’s expectation of £70.5bn.

Instead, public spending was higher than expected. Debt interest payments, linked to higher inflation, were £8.2bn, much higher than the £4.9bn expected, and other public spending also exceeded forecasts.

The one bright spot in the figures was that borrowing for the first four months of the financial year was revised down by £8.6bn, leaving the starting point close to original OBR estimates.

During her visit to the US on Tuesday, Truss said she wanted to cut taxes further to boost growth, and aides have not denied reports that the government is considering stamp duty reductions on top of cuts to national insurance and a reversal of plans to increase corporate tax rates.

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