PANDEMICS ARE a costly affair for governments. Last year UK government bonds reached over 14% of GDP, the highest figure in more than seven decades. All of this additional borrowing helped push the public debt ratio up to GDP from about 80% to almost 100%.
For the moment, this is proving to be less expensive than expected. The debt may have gone up, but the interest charges have gone down. In the year ended March, interest payments amounted to 1.1% of the GDP, against 1.7% the previous year. But that could change. Like a homeowner with a big mortgage nervously eyeing an interest rate calculator, Chancellor Rishi Sunak worries about what will happen if he does.
The Office for Budget Responsibility, a budget watchdog, kindly did the sums for Mr. Sunak. He began to sprinkle his speeches with a warning that if interest rates and inflation were to rise by a percentage point, Treasury interest bills would rise by £ 25bn (£ 35bn). dollars), an amount equivalent to the annual budget of the Ministère des Transports. Underlying the Treasury’s concern is the fear that quantitative easing has had a paradoxical impact on public finances: helping to contain borrowing costs for now, but increasing the government’s exposure to interest rates. short-term interest.
Since 2009, the Bank of England’s quantitative easing program, through which it electronically creates reserves to buy bonds, has made it a major player in government debt markets. In April, the bank became the UK government’s largest holder of gilts, with around a third of the outstanding shares now on its balance sheet.
One of the benefits of quantitative easing for the government is that the debt held by the bank is cheaper to repay. He only has to pay the interest rate charged on reserves at the Bank of England, which is 0.1%, rather than higher market rates. But there is a potential downside. While a hike in the bank rate would have taken years to spill over into government borrowing costs, as much of the debt would have been issued when rates were lower, today its impact is would be felt immediately.
The Treasury should nevertheless relax a bit. Over the past few decades, and especially since 2010, the Debt Management Office, which issues UK government debt, has worked to lengthen the maturity profile of this loan, thus protecting the government from short-term rate hikes. Indeed, Britain has the longest average maturity of any advanced economy. On May 27, Gertjan Vlieghe, a member of the Bank of England’s Monetary Policy Committee, pointed out that even taking into account the impact of quantitative easing by assigning a maturity of zero to all debts held by the bank, Great Britain still compares favorably with its peers (see graph).
A scenario in which interest rates and inflation increase would see the cost of government borrowing increase. But such a scenario would almost certainly include healthier tax revenues, since rising interest rates normally keep pace with economic growth. All of this means that UK public finances are more sustainable than the usual measures suggest. Mr. Sunak doesn’t need to panic. ■
This article appeared in the Great Britain section of the print edition under the headline “Well ripened”