The UK’s debt-to-GDP ratio has exceeded 100% for the first time since 1961, primarily due to inflation and soaring interest rates. This development comes as a setback to Prime Minister Rishi Sunak’s promise to lower the country’s debt, and also dampens the hopes for major tax cuts in the run-up to an anticipated general election next year. The private-sector economists and the OBR (Office for Budget Responsibility), who estimated that revenue would exceed expenditure by a lesser margin, were taken by surprise as the Treasury spent an excess of £20 billion ($25.5 billion) in May. For the first two months of the fiscal year, the Treasury’s budget deficit reached £42.9 billion, more than twice the same period last year and £2.1 billion higher than OBR’s estimates.
The UK government's finances currently stand in the way of the Conservative Party's desire for significant tax cuts, which several members deem essential to avoid a defeat at the next general election. This view is supported by opinion polls that show the Tories consistently lagging behind the opposition Labour Party by double digits. The Office for National Statistics revealed that factors that contributed to the breach of the debt threshold were caused by the inflation crisis, which has led the Bank of England to raise interest rates from a low of 0.1% to 4.5% since the end of 2021.
Inflation-indexing of benefits contributed an additional £2.9 billion to welfare spending, while support for household energy bills in May cost £3.6 billion. The National Health Service (NHS) settlement led to higher wage costs, with costs for May £3.4 billion higher than the previous year. Debt-servicing costs, which have risen as a result of surging inflation, were slightly lower than a year ago at £7.7 billion, but still higher than what the OBR had projected. Additionally, the data for May revealed that spending was greater than anticipated, whereas receipts were slightly lower.
According to the EY ITEM Club, borrowing is expected to be approximately £20 billion more than the OBR's estimate of £132 billion this year. If market rates continue to rise, the government is likely to "violate its fiscal policies," the forecasting body explained. The government's March budget allowed for only £6.5 billion of headroom against the rule that government debt must decrease as a percentage of GDP by the end of its fifth year of forecast. Borrowing costs increase by roughly £20 billion for each percentage point increase, and current market rate projections are approximately 1% higher than in March.
Chancellor of the Exchequer Jeremy Hunt stressed that it would be unfair for future generations to be left with debt, which they could not repay, adding that the government had made "difficult but necessary decisions" to balance the budget and decrease inflation while boosting economic growth. Ruth Gregory, deputy chief UK economist at Capital Economics, claimed that these figures raised doubts about the Chancellor's ability to offer significant tax reductions before the next general election while still adhering to fiscal guidelines. Any significant tax cut could be "modest or quickly reversed," she warned.
Martin Beck, chief economic advisor to the EY ITEM Club, predicts that a Conservative government would increase austerity in the years following the election, which must occur by January 2025 at the latest. He predicted that the Chancellor would react by imposing additional post-election spending cuts, adding to an already challenging spending squeeze. As a result, the actual medium-term fiscal policy's path is unlikely to emerge until after the election, he concluded.