CHANCELLOR
The national debt is now at its highest level since the 1960s.
The Bank Rate has climbed from just 0.1 per cent at the end of 2021 to a post-financial crisis high of 5.25 per cent. Although debt interest spending is now on the way down, the higher cost of borrowing means it is expected to be around 4.3 per cent of GDP in 2023-24, the second highest level since World War Two.
That is a lot of money. Put another way, government spending on debt interest this year will be nearly double the
So it's worth asking whether the decisions the government have taken over the past couple of decades have increased its exposure to interest rate risk unnecessarily.
There are a couple of obvious candidates.
First, the
These bonds were introduced in 1981 in an attempt to assuage concerns among international investors that the
'
The argument in defence is that investors pay a premium for inflation protection allowing the government to offer investors a lower yield.
The problem, however, is that when interest rates start rising, the government has to pay out more in debt interest payments. The
In 2022, the
So have they been worth it in the long run?
The Debt Management Office (DMO) suggests that the government made savings of £77bn on gilts issued since 1981, prior to August last year. Not bad.
However, there are very good reasons to think that inflation, while coming down now, will be higher over the coming years than in the previous four decades. DMO analysis suggests that as long as the retail price index averages less than three per cent over the life of the bond, then the government still gets value for money.
That looks like a much riskier bet in 2024 than it did in 2014.
Another factor impacting the
For over a decade after the financial crisis, the Bank was buying government bonds on the secondary market in an attempt to stimulate the economy.
To buy the bonds, the Bank created new commercial bank deposits on which it had to pay interest. This effectively ties the gilts bought by the Bank directly to changes in interest rates. In a way, this turns fixed-rate debt into floating-rate debt.
Now that interest rates are significantly higher, the government is transferring commercial banks billions of pounds via the
Policymakers at the Bank have stressed that QE - and its reverse, quantitative tightening - should be judged by its macroeconomic effects rather than its cost-effectiveness.
There is no doubt that QE was crucial to help address the 2008 financial crisis, but the Bank has come under criticism for the scale at which QE was pursued during the Covid pandemic.
The government could have borrowed from the market instead, locking in the very low rates that existed at the time of the pandemic, rather than exposing itself to the risk of interest rates rising in the future.
The
(c) 2024 City A.M., source