Government debt will rise to 140% of GDP, think tank forecasts
High levels of national debt will hurt the UK’s ability to fund public services and respond to economic crises, a think tank has said.
Not in the last 300 years has there been as large a peace time increase in the amount of government borrowing, the Resolution Foundation said.
In the last 15 years alone there’s been a trebling of the ratio of debt to a measure of economic output, called gross domestic product (GDP), the foundation’s Built to Last report said.
Since 2007 the UK’s debt-to-GDP ratio grew from 36% to 100% of GDP in May this year.
The knock-on effect is difficulty in funding services and increasing spending in the event of potential future economic crises, the report said.
And the debt ratio will rise further, according to the report authors.
They forecast it will reach roughly 140% of GDP over the next 50 years if current market expectations are correct – that the UK continues to have high interest rates in the longer term.
Present market expectations, according to market data provider Refinitiv, are that the Bank of England’s base rate will remain above 5% to the end of December 2024.
The central bank has brought up interest rates to 5.25%, making borrowing more expensive and saving more rewarding, in an effort to take money out of the economy in an effort to reduce spending and bring down inflation.
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Rate of inflation fails to fall
Inflation, the rate of price rises, has remained stubbornly high after COVID-19 era supply chain problems pushed up costs, and was significantly worsened by the energy price highs seen after Russia’s invasion of Ukraine.
Each percentage point rise in the base interest rate is adding around £15bn to government borrowing costs in five years’ time as the amount owed on that debt goes up, the report said.
That cost could therefore rise to roughly 5% of GDP – the highest for more than 70 years, it added.
Reducing state debt has political significance as Prime Minister Rishi Sunak has made it one of his five priorities to bring down borrowing.
The report contains criticism of government spending and calls for new a monetary policy for the Bank of England.
Specifically, two forms of state support were poorly targeted, the report said; the “generous” grants to self-employed workers who did not report income falls in the COVID-19 years and the universal nature of household energy supports – such as the energy price guarantee – given to customers up to the end of June to deal with energy bills.
Had the schemes been targeted to those who needed financial help, their overall cost could have been reduced by £35bn, the Resolution Foundation said.
Monetary policy should be changed with the target rate of inflation brought up from 2% to 3%, the report added, but this should only be done when interest rates are low again and when the rate of inflation has reached the current 2% goal.
The value of the pound has sunk – as the cost of 30-year government borrowing reached a high last seen in 1998.
The so-called spot rate saw one pound buy $1.336 on Tuesday, a low last seen in early August, and down from $1.353 earlier in the day.
Despite the dip, it’s still higher than the vast majority of the past year: in early September 2024, a pound bought $1.31.
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The decline, however, means sterling is on course for the biggest one-day drop since April, when Donald Trump’s announcement of country-specific tariffs spooked markets.
The drop was similarly steep against the euro, with a pound momentarily buying €1.1486, a low not seen since November 2023, nearly two years ago. It’s also a fall from €1.1586 earlier in the trading session.
Before the so-called liberation day announcement, £1 equalled nearly €1.19.
It comes as the yield – the interest rate demanded by investors – on 30-year government bonds – loans taken by the state – hit 5.72%, the highest rate this century.
Why?
Yields are rising across the globe in the face of weak economic growth and the US trade war.
Investors are also concerned about UK government finances as Chancellor Rachel Reeves battles to stick to her fiscal rules to bring down debt and balance the budget.
High inflation and increased public debt from the pandemic have left a deficit between state spending and income.
There have been high-profile government U-turns on winter fuel payments and welfare spending cuts that have meant the chancellor has to look elsewhere to meet her self-imposed fiscal rules.
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More expensive interest payments from rising bond yields have meant the country is stuck in a cycle of rising debt.
Today’s rises to the cost of government borrowing could not have come at a worse time for the public finances.
While a £14bn sale of new 10-year government debt – a record sum – was completed, it was achieved at the highest yield since 2008.
Lale Akoner, global market analyst at investment platform eToro, said of the auction: “For the government, this creates a paradox – market confidence in UK debt is robust, but financing that debt is increasingly expensive, constraining budget flexibility and raising the stakes for fiscal discipline ahead of the autumn budget.”
The yield on 10-year gilts, as they are known in the UK, later rose to its highest since January at 4.825%, up on the day but in line with their transatlantic equivalent, US Treasuries.
The global bond sell-off was also being reflected on stock markets.
The Dow Jones Industrial Average and tech-focused Nasdaq were both down by more than 1% at the open on Wall St.
In Europe, Germany’s DAX was 2% lower while the FTSE 100 was just 0.6% down as it is less exposed to declines in technology stocks which have accounted for much of the value growth seen over the summer.
The flight from risk also saw the spot price of gold, traditionally a safe haven for investors in times of uncertainty, briefly climb to a new record high of $3,578.40 per ounce.
Nestle shares opened down more than 2.5% after the maker of Nescafe, Cheerios, KitKat, and Rolos dismissed its chief executive after an investigation into an undisclosed romantic relationship with an employee.
On Monday night, Nestle announced that the immediate dismissal of Laurent Freixe, effective immediately, following the investigation into the relationship, with a direct employee, which had breached the company’s code of business conduct.
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The replacement for Mr Freixe was announced as being Philipp Navratil, a long-time Nestle executive and former head of Nespresso, the brand of coffee machines owned by Nestle.
It’s the second CEO departure from the Swiss food giant in a year.
Nestle’s chief executive, Laurent Freixe. File pic: Reuters
Mr Freixe’s predecessor, Mark Schneider, was suddenly removed a year ago, and in June, the longstanding chair, Paul Bulcke, announced he would step down in 2026.
No further detail on the relationship was released by the company, nor was additional information on whom the person Mr Freixe had the relationship with.
Mr Bulcke, who led the investigation, said: “This was a necessary decision. Nestle’s values and governance are strong foundations of our company. I thank Laurent for his years of service at Nestle.”
Mr Freixe had been with Nestle since 1986, holding roles around the world, including chief executive of Zone Latin America.
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Nestle’s shares, a bedrock of the Swiss stock exchange, lost almost a third of their value over the past five years, performing worse than other European stocks.
The appointment of Mr Freixe’s had failed to halt the slide, and the company’s shares shed 17% during his leadership, disappointing investors.
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