UK on Borrowed Time as Debt Interest Tops Developed World

Higher for longer is increasingly looking like the safest bet for the direction of UK interest rates.

Huw Pill, the Bank of England’s chief economist, underlined that message last week when he told the Wall Street Journal that stronger-than-expected economic growth in the first half of the year strengthened the argument for keeping rates elevated.

His comments matter not only because, as chief economist, he sees data unavailable to most observers, but also because they will have been closely watched by US investors who have bought gilts, the UK Government’s debt.

If the Bank were judged to be easing up in its fight against inflation — especially when its credibility is already under pressure — confidence in sterling and in the Government’s ability to finance its growing debt burden could be hit.

Fresh clues are due this week, with July inflation data published on Wednesday alongside updates on the public finances. City economists expect the Consumer Prices Index to rise from 2.6 per cent to 2.8 per cent, before climbing above 3.5 per cent later in the year.

For financial markets, that leaves the Bank of England with little room for complacency. Money market rates offer a clear gauge of where investors believe policy will have to go next.

These point to the Bank’s base rate rising to 4 per cent this year, to 4.25 per cent next, then staying above 4 per cent for the rest of the decade.

Pill was one of the three members of the Bank’s Monetary Policy Committee who voted for a rise in rates last time. 

He and his fellow hawks were outgunned last month, but the markets think their judgment that the Bank has to show some steel in fighting inflation will be proved right. Government borrowing numbers come out on Friday. 

The background here is that the first two months of this financial year were dreadful, with the deficit running a quarter above forecast.

Then the June figures were better, so that borrowing overall was only a bit higher than projected. It’s still terrible – just not quite as bad as it might have been.

You don’t want to get too worked up about one month’s figures but if this lot show the deficit running above target it bodes ill for our new Chancellor trying to frame his budget on October 28.

The big point here is that confidence in this new government is on a knife-edge. You may have read about the Government trying to find more room to spend by tweaking the rules of the Office for Budget Responsibility. 

The Trades Union Congress has further undermined global trust in the OBR by calling for ‘root-and-branch’ reform to allow more public investment, which would require yet more borrowing. This shows how little these people understand how the world works.

It’s like putting in a mortgage application that says – aside from the £250,000 you need to buy the house – you will borrow another £50,000 to put in a new kitchen to make nice meals and save the money you spend on restaurants.

Oh, and if your mortgage supplier doesn’t like the idea, you’ll go borrow from someone else.

Little wonder the yield – or effective interest rate – on ten-year gilts pushed back above 5 per cent in Friday trading, close to its highest level since 2008. 

I’ll say it again, the UK has to pay a higher rate of interest to fund its debt than any other large developed country. And it’s we, as taxpayers, who have to stump up.

So what will happen? We are a resilient lot and have a resilient economy. That’s why we’ve been able to grow a bit faster than the US and Canada, and much faster than Germany and Italy in the first half of this year. 

France, by the way, did not grow at all. But we’ll have inflation way above target and relatively high interest rates for the foreseeable future.

It may simply be a long grind ahead that we have to cope with.

But we may also have to accept a serious reversal in the next couple of years. That could take the form of a recession, perhaps triggered by a slump in property prices. I don’t like the feel of our housing market right now, with squeezed incomes and the prospect of higher interest rates.

Or it could be a widespread loss of confidence in this Government leading to a sharp fall in gilt prices and an emergency budget.

Either way, we are going to need all the resilience we can muster.