The cost of servicing our record debt is low, but how long can this last?

Rishi Sunak’s face was a “complete picture of shock” when Boris Johnson offered him the job of Chancellor in February last year, according to the Treasury’s glitzy video trailer of today’s Budget.

So just imagine his expression had he known that in a matter of weeks he would be on the way to racking up the UK’S biggest ever peacetime deficit.

The numbers today from the Office for Budget Responsibility are likely to confirm borrowing of about £360billion and a debt pile heading towards £2.3trillion, over 100 per cent of GDP and the highest since the 1960s. The Chancellor is polite and articulate, but even he might have reached for something a little more Anglo-saxon than “Oh, gosh”.

The enigma is that even as the UK’S debt burden swells, the cost of servicing it has tumbled to an all-time low. As of January, the UK’S net debt stood at £2.1 trillion, but in the same month the Government paid just £1.8 billion in interest, less than half the amount paid 12 months ago. It is also at a record low as a share of the Treasury’s revenues, at just 2.2 per cent. The key question for Mr Sunak is how long that can last. Squalls in global debt markets pushing up the cost of borrowing have raised concerns that the low rates needed to service Covid-19 debt mountains may not last forever. The Chancellor himself has warned of an extra £25 billion interest bill by the end of the Parliament from a percentage point rise in Government debt costs.

Politically, it suits him to begin making small down-payments on Covid-19 borrowings through targeted measures such as corporation tax, even though he will almost certainly be spending billions more than he gathers in this year. Extending furlough until September and other measures such as business rates relief will see to that.

Economically, however, it makes less sense. With the signalling of raised taxes, the Chancellor is pandering to the so-called “household fallacy” that governments do not have to behave like belt-tightening households and it can be counterproductive if they do. In any case, even before the virus struck, there were big structural forces pushing down long-term interest rates around the world, making a sudden debt interest rate shock less likely. Swollen debt piles may alarm some fiscal hawks, but the factors in play include an ageing global population wanting to hold more savings, as well as weakening productivity trends as firms seek out less capital for investment.

Those trends have been exacerbated by the virus as governments crank up their deficits to pay for pandemic support. The supply of new debt has been more than matched by investors hunting for safe assets during the turmoil of the past 12 months, as well as central banks buying up the bonds through quantitative easing (QE) to bring down interest rates and pour on economic stimuli.

That pressure has driven down debt costs further, but economists and credit ratings agencies also suggest the Chancellor has little reason to fear a sudden debt spike. The UK has had its banking crises, but it is one of the few countries never to have defaulted on its debt. In the Bank of England it has a credible, independent central bank. The strength of those institutions as well as the position of sterling as one of the world’s major reserve currencies make it a safer bet for global investors.

The debt market ructions triggered by inflationary concerns over President Joe Biden’s outsized $1.9 trillion (£1.4 trillion) stimulus plans should also be put into context. Even after a sell-off, the UK’S own benchmark cost of borrowing for 10 years remains low by historical standards; at just under 0.7 per cent it is roughly where it stood in January 2020. Sir Robert Chote, the former head of the OBR, said last week that “given the funding conditions at the moment, there doesn’t seem to be a pressing requirement” to start chopping at the deficit. Olivier Blanchard, former International

Monetary Fund chief economist, has said that as long a nation’s economic growth is faster than the rate of interest on its borrowing, debts will stabilise or fall over time anyway. That said, Andy Haldane, the Bank of England’s chief economist, fretted over “letting the inflation cat out of the bag”, while the OBR flagged that the Bank’s £875 billion holdings in QE bonds, funded by short-term bank reserves, make debt servicing costs more vulnerable when interest rates eventually rise.

Julian Jessop, of the Institute for Economic Affairs, points out that by time the Bank feels ready to raise rates, it will be due to recovering inflation and growth. “On balance that combination is still going to leave public finances in a better state than if we remain where the economy is in recession and inflation is too low.”

This all bodes well for Mr Sunak despite his determination to “level with” the public about the pandemic bills. Politically it suits him to draw dividing lines with Labour and slap down cash-hungry spending departments by sounding tough on “sustainable” finances. In reality the UK’S debt dynamics look stacked in his favour for a while to come.