Inflation rises could blow up Sunak’s plans

CHANCELLOR Rishi Sunak has been warned he is sleeping on a “bed of nitroglycerin” and his Autumn Budget calculations could be blown to pieces if inflation continues to rise.

The Bank of England could be forced to hike interest rates to curb inflation, as prices soar due to higher energy costs and supply shortages.

That would drive up the cost of servicing the UK’S massive debts and wipe out much of the revenue Sunak expects to generate from this year’s controversial tax increases.

In 2010, bond guru Bill Gross warned the UK gilt market was sitting on a “bed of nitroglycerine” and although it has not exploded yet, Aj Bell investment analysis Laith Khalaf said it could blow soon. “Gross made his prediction a decade early, but risk is growing and the impact could be even greater today.”

The Bank of England has pegged £875billion of debt to base rate rather than locking into long-term fixed rates on the gilt market, Khalaf warned: “Base rate is a floating interest rate that can change overnight.”

In March, the Office for Budget Responsibility said that if interest rates rose by just 1 per cent, it would add an incredible £20billion to the average cost of servicing the nation’s debt.

Khalaf says this “would wipe out all the £8.2billion gain the Treasury expects from freezing income tax allowances, as well as a chunk of the £17.2billion rise in corporation tax”.

Gilt yields have doubled from 0.5 per cent to a two-year high of around 1.10 per cent in just two months. “Bonds are a traditional safe haven but this may be giving investors a false sense of security,” he added.

Khalaf said 12 years of ultraloose monetary policy have driven gilt prices so high the crash could be brutal. “Some UK bond funds have sustained double-digit falls this year.”

Even if inflation retreats Khalaf said this would just be a stay of execution. “Unless we believe loose monetary policy and low interest rates are here forever, there will be a day of reckoning for the bond market. It’s a question of when, not if.”

Tilney managing director Jason Hollands said in times of uncertainty, investors fly to the perceived safety of government bonds: “That would be a very dangerous move today. Bond yields are negative in real terms, but prices are high.”

Fawad Razaqzada, market analyst at Think Markets, warned that central bankers are helpless against “stagflation”, where the economy stagnates while prices rise: “Further loosening will overcook inflation.”