City comment: Inflation adds to Rishi Sunak’s debt headache

Chancellor of the Exchequer Rishi Sunak (PA Wire)

Borrowing is gradually coming under control but there’s another spectre on the horizon for government finances: inflation.

This morning’s public sector finances data shows borrowing is gradually coming down from sky high levels. The Treasury borrowed £18.8 billion in October, which is historically high but down £200 million on the same level last year. The end of furlough means the numbers should start to ease further.

But as borrowing declines, debt costs are going up. Repayments have risen over 200% in the last year to £5.6 billion, largely driven by inflation. Around a quarter of UK government bonds are linked to the retail price index (RPI), a measure of inflation. RPI has risen from 1.4% at the start of the year to 6% and is set to climb even higher next year under Bank of England forecasts.

The Bank still argues that price rises will be temporary and should ease. But interest rates look set to go up, another headache for the government. The Office for Budget Responsibility says a 1% increase in rates would add £20 billion to government debt costs. That’s a big chunk of change.

Optimists point out that UK debt servicing costs are near historic lows thanks to rock bottom interest rates. The Bank of England could take years to put rates up to more ‘normal’ levels.

Still, it’s easy to see why Rishi Sunak is getting sweaty palms.

The Chancellor is sitting on a £2.2 trillion debt pile that may look manageable now but could soon get out of hand. No wonder he’s looking to squeeze every penny he can in Whitehall.

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