By Paul Hannon
The U.K. government's budget deficit surged in the final month of 2024, underlining the challenge facing the government in meeting its fiscal rules as interest rates remain high and growth weak.
The Office for National Statistics said Wednesday that government spending exceeded revenue by 17.8 billion pounds ($21.99 billion) in December, a deficit that was 10.1 billion pounds higher than a year earlier and well above the 14.2 billion pounds forecast by the Office for Budget Responsibility, which monitors compliance with the fiscal rules.
One factor driving the increase was interest payments, which were 3.8 billion pounds higher than in the same month of 2023.
For the fiscal year to date, the government borrowed 129.9 billion pounds, 8.9 billion pounds more than over the same period in the previous fiscal year and the second highest figure on record after 2020, when the Covid-19 pandemic led to a jump in spending.
The OBR is projecting a budget deficit of 4.5% of annual economic output in the fiscal year ending March. By comparison, the U.S. equivalent of the OBR is forecasting a budget deficit of 6.2% in the fiscal year ending September.
But while borrowing for this year is slightly ahead of projections, the outlook is more uncertain, with some key factors likely to remain beyond the government's control. Nevertheless, the U.K.'s Treasury chief Wednesday reaffirmed the government's determination to stick to its fiscal rules.
"We will continue to make decisions to make sure we meet those fiscal rules," said Rachel Reeves.
The first problem for the government is that its borrowing costs seem set to be higher than it had expected. That would increase the amount it has to pay in interest over coming years, and possibly require cuts in spending on other items, or tax rises to meet its rules, which include a commitment to borrow only for investment and not to pay day-to-day bills five by the fiscal year ending March 2030.
Yields on U.K. government bonds--which are known as gilts--surged in early January, and although they have since fallen back somewhat, they remain above the levels assumed by the OBR when it was making its assessment of the government's budget in October.
But the government has little immediate influence on yields, which are largely being determined by movements in U.S. government bond markets. When yields on U.S. government bonds rise, so too do yields on U.K. government bonds. According to credit ratings agency S&P Global Ratings, 80% of changes in U.S. 10-year yields are reflected in the U.K. gilt market.
It is possible that U.S. government bond yields will rise further as the government's debts continue to grow. The U.S. Congressional Budget Office on Friday said government debt would reach 99.9% of gross domestic product later this year and surpass its post-World War II high as a share of the economy by 2029, while annual deficits would stay at levels the U.S. normally doesn't reach outside of wars, recessions and crises.
"U.S. rates can still edge higher," economists at ING Bank wrote in a note to clients. "This would keep gilt yields elevated for the time being.
However, S&P said higher borrowing costs are unlikely to derail the U.K. government's debt plans. S&P rates the U.K. as an AA borrower, just one rung below the U.S. in its scale of credit worthiness, and one step above France.
"In our view, albeit U.K.'s fiscal position is constrained, it remains manageable," it said in a note released Friday. "The recent rise in cost of financing does not have immediate implications on our sovereign ratings."
The other problem that the U.K. government faces is compounded by the first, since higher yields on gilts raise borrowing costs for businesses and households. The economy is growing more slowly than the OBR had anticipated, and that means that tax revenues may come in weaker than forecast.
Growth is set to pick up this year in response to measures announced by the government in its October budget and subsequently. Indeed, the International Monetary Fund on Friday raised its growth forecast for this year to 1.6% from 1.5%. But that remains below the 2% forecast on which the OBR's budget projections are based.
Those pressures on the government's finances have made some investors wary of owning too many gilts. While most governments saw their bond yields follow the U.S. higher in early January, the U.K. was among the hardest hit.
Economists say that is partly because the U.K. government has recently announced a big increase in spending, in contrast to most other European countries, while also raising taxes.
Moreover, ownership of gilts has changed over recent years, according to economists at Deutsche Bank, with foreign investors having bought a larger share, and domestic pension funds and other institutions playing a smaller role.
But the U.K. also became the focus of investor attention because its fiscal rules immediately raised the question of whether the government should cut spending or raise taxes to offset the rise in borrowing costs and slower growth. Other European governments operate within the European Union's budget rules, which leave more room for maneuver.
"This episode is an excellent example of the downsides of having a bright-line, pass-fail fiscal rule, measured against a highly uncertain forecast, and aiming to meet that rule almost exactly," said Ben Zaranko, an economist at the Institute for Fiscal Studies.
Write to Paul Hannon at paul.hannon@wsj.com
(END) Dow Jones Newswires
01-22-25 0308ET