Sunak’s room for giveaways cut by cost of borrowing
Higher than expected inflation could force the Chancellor to find extra billions to service debt
SURGING inflation is set to cost Rishi Sunak an extra £12bn this year, potentially squeezing his ability to offer more giveaways in the Budget.
About a quarter of the £2.2 trillion in national debt is tied to the retail price index (RPI), so the unexpected jump in inflation forces the Treasury to pay more to investors who own gilts.
When the Chancellor was doing his sums in March, the Office for Budget Responsibility (OBR) thought the annual RPI rise would peak at 3.1pc in the three months to June.
However, RPI inflation hit 3.9pc that month and is expected to rise further over the rest of the year as distortions caused by last year’s slump and this year’s recovery combine with widespread shortages to push up prices.
Samuel Tombs at Pantheon Macroeconomics expects it to rise to 4.9pc in the closing months of the year.
“Our forecast for further above-trend month-to-month increases in the RPI over the next nine months implies that debt interest payments will overshoot the OBR’S March Budget full-year forecast by about £12bn,” he said. It will be a permanent drag on the public finances every year.
So far this financial year, the Chancellor has built up some headroom against the OBR’S forecasts, with the deficit coming in £26bn lower in the first four months than anticipated, thanks to the economy’s stronger recovery.
Inflation could rise even further. Fabrice Montagne, economist at Barclays, expects RPI rises to peak at 5.5pc near the end of the year with each extra percentage point adding about £6.5bn to the Government’s bill. But he also notes that rising inflation adds to the cash size of the economy, with some tax revenues rising as a result, bringing in another £500m or so for the Exchequer.
The Treasury is also set to benefit from lower borrowing costs on billions of pounds of green gilts due to be launched next month amid a scramble for ethical investments.
Analysts at BNP Paribas expect the new bonds to price with a “greenium” of two to four basis points as investors pay more to hold the climate-friendly government debt amid huge demand. These green government bonds will be used to pay for environmentally friendly investments.
Chris Lupoli, UK rates and inflation strategist at BNP Paribas, said: “It’s a really key and important moment from
‘The Debt Management Office is trying to create growth for a broader sterling based ESG market’
a market perspective as well as all other factors. What the Debt Management Office is additionally trying to achieve is to create the green shoots of growth for a broader sterling based ESG market.” The DMO revealed on Friday that the first green gilt will be launched in the week of Sept 20. Mr Lupoli expected up to £20bn of green gilts to be issued this year given the demand.
A Treasury spokesman said: “The independent Monetary Policy Committee of the Bank of England has responsibility for controlling inflation, and have kept CPI inflation around the 2pc target on average. “We closely monitor inflation and, in the March Budget, have set out the actions we are taking to ensure the public finances return to a sustainable footing.”