Inflation raises cost of servicing national debt to 25-year high

The cost of servicing government debt has hit its highest point in 25 years because of rising inflation.

The cost of interest payments on government debt was £19.4 billion, more than double that of June 2021, official figures show — the highest since records began in 1997.

Government bonds are indexed to the retail prices index, which hit a 40-year high of 11.8 per cent last month, according to official figures.

The rise in interest payments took a toll on the government’s borrowing bill, which does not include debt servicing costs. Net borrowing rose to a near record £22.9 billion in June, exceeding the Office for Budget Responsibility’s forecast by £600 million.

This represents a rise of £4.1 billion from the year before to reach the second-highest level of borrowing in June since records began in 1993.

Government tax revenues rose because of higher numbers of people in work and higher wages. Tax receipts hit £51.4 billion, up by £5.1 billion compared with June last year. However, the combination of a further weakening in economic activity and more interest rate rises is likely to push government borrowing well over the OBR’s 2022-23 forecast of £99 billion.

Ruth Gregory, of the Capital Economics consultancy, expects it to be close to £110 billion in the current financial year. “Borrowing is £3.6 billion higher than the OBR expected at this stage,” she said.

“And that’s before taking into account the net £10.3 billion handout by the chancellor in May and a possible further fiscal loosening in the autumn, as well as the further upward impact on borrowing from rising interest rates and weaker real gross domestic product growth coming down the line.”

She warned that the further deterioration in borrowing in June “provides a timely reminder to the next prime minister that the public finances are weaker than the OBR’s forecasts suggest”.

Economists at Pantheon Macroeconomics, the consultancy, expect borrowing to hit £130 billion based on the government’s current policies.

Rishi Sunak, the former chancellor, announced a £21 billion support package in the spring for households facing the toughest cost of living crisis in a generation. The scheme will be funded by a windfall tax on North Sea gas companies and higher borrowing.

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Debt has hit levels last seen in the 1960s, with public sector net debt at nearly £2.4 trillion at the end of June, about 96.1 per cent of GDP.

Michal Stelmach, senior economist at KPMG UK, said: “Today’s figures put paid to the idea that inflation is an effective tool for reducing debt. The accrued debt interest in June is sufficient to fully offset the £18 billion expected yield from the income tax threshold freezes by 2025-26, which push people into higher tax brackets as their nominal incomes rise.”

Liz Truss, who is facing Sunak in the race to become the next prime minister, plans to cut taxes as a way of boosting economic growth. She believes that the cuts would also increase government revenues and bring down inflation — a claim contested by Sunak, who has said inflation must be brought under control before tax cuts are made.