Interest rates impacting debt costs slower in UK than any other G7 country

Published alongside the OBR’s Autumn Statement forecast, the report said that the UK’s refinancing costs and debt servicing costs were impacted “more slowly” than any other G7 country. This was due to its history of issuing a high proportion of long-dated gilts.

The assets lowered annual refinancing needs and reduced exposure to interest rates, “all else equal”, the report said.

However, this did not mean this method of debt management was without risk, as the FRS addressed the sensitivity of the consolidated public finances to rising interest rates had increased due to quantitative easing by the Bank of England.

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The government said the average maturity of the total stock of gilts was “significantly higher” than other G7 countries, even after adjusting the UK figure for the impacts of QE and without applying any QE adjustment to other countries which will also face significant QE effects.

On the current trajectory,  the government said the effect on maturity was “now unwinding” as QE eases, “which will increase the UK’s effective debt maturity, all else equal”.

The UK’s allocation to a relatively high share of index-linked debt was also noted in the FRS, which was analysed on a balance of cost-effectiveness and overall risk.

The FRS said there were savings benefits for taxpayers using this asset. For pension funds, it prevents them from having to pay a premium for inflation protection compared to nominal gilts.

Analysis by the Debt Management Office (DMO) showed that for gilts which had matured since their introduction in 1981, but prior to August 2023, the government generated direct savings of around £158bn. However, it added that it was “important to balance the cost benefits with the risks”.

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To mitigate and manage the inflation risk of these assets, as the returns on index-linked gilts change regularly in line with movements in inflation, the FRS said the government had been consistently reducing the proportion of index-linked gilts since 2018, prior to the recent period of high inflation.

It went from accounting for 25% of the government’s debt issuance in the five years prior to 2018-19 to just 14% over the last five years.

OECD analysis, which considers movements in inflation and impacts of quantitative easing, showed that the UK had a lower proportion of debt refixing at the three-year horizon than Japan, Canada and the US.

Issuing index-linked gilts was also said to “underline the government’s stated commitment to low and stable inflation, reducing investors’ perception of inflation risk and hence the yields they seek on nominal gilts”.

Without action, the FRS projected public sector net debt would reach 310% of GDP by 2072-73, 31 percentage points higher than the FRS 2022 projections due to the expectation of higher for longer rates.

The FRS noted that the government’s decisions to improve the primary balance contributed to around 9% of GDP reduction to debt by the end of the projection period.

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The OBR also categorised risks into shocks, policy risks or long-run trends. One of the shocks mentioned was the “recent episodes of global financial sector stress”.

FRS said it recognised the reforms made to the banking sector by both the government and the regulator, such as increased capital and liquidity requirements .

“Financial sector risk did not crystallise despite the strains of the pandemic, reflecting the strengthening of capital requirements and other banking regulation since the 2008 financial crisis,” it said. 

Policy risks included local authority borrowing and increasing clinical negligence payouts. Health and social care spending, global trade cooperation and a decreased likelihood of a narrowing of income and capital tax were identified as long-run trends.

The OBR confirmed in its November 2023 forecast that the government was on track to meet its aims to lower borrowing and debt. It said borrowing is below 3% of GDP three years ahead of target and underlying debt is predicted to fall in the fifth year of the forecast.