• The public finances recorded a surplus of £2.9 billion in January, according to the latest figures released by the ONS today today
• But inflation pushed debt interest payments to a January record of £6.1 billion, up from £1.6 billion in the same month last year
• More inflation in the pipeline will further increase the cost of the government’s RPI-linked debt
• Borrowing is currently running £17.7 billion below the OBR forecast, and the end of COVID rules and testing will help government finances
• But higher inflation and interest rates could spoil the Chancellor’s party on Budget day
Laith Khalaf, head of investment analysis at AJ Bell, comments:
“Inflation is a double-edged sword for government finances. On the one hand rising prices and wages increase the tax take, but at the same time the government has to shell out more to service the £500 billion of index-linked gilts it has used to fund its spending. The latest figures from the ONS showed that interest payments on these RPI-linked gilts pushed government debt interest up to £6.1 billion in January, up from £1.6 billion in the same month last year. The bad news is that there’s more inflation in the pipeline, which is only going to send this number in one direction.
“Inflation also means rising interest rates, which increases the bill the government has to pay on the gilts held in the QE scheme. If that’s not enough, inflation has pushed up the yield on conventional gilts, which means the government now also has to pay more when it issues fresh debt. All that could leave the government facing a cost of borrowing crisis if inflation persists at high levels.
“As long as the economy is motoring along, the cash coming into the Exchequer should help to offset the higher interest payments on the government’s debt mountain, particularly in light of the tax rises that are coming in this April. Indeed, the public finances recorded a surplus of £2.9 billion in January, thanks to self-assessment tax receipts. While this is below the £9.9 billion surplus recorded in January 2020, before the pandemic, it’s still a marked improvement on last year’s £2.5 billion shortfall, especially when considering that many of the taxes collected will be for the tax year spanning from April 2020 to April 2021, which was a pretty bleak period for economic activity.
“There’s more good news for the Chancellor in that so far this fiscal year, borrowing is running £17.7 billion below the latest OBR forecast, which should free up some money in the forthcoming Budget. Likewise the reduction in COVID support and testing announced by the Prime Minister should also alleviate pressure on the government’s finances. However the OBR will also have to factor in the worsened outlook for inflation, and with that the expectation for the Bank of England to raise interest rates aggressively this year. The increased cost of borrowing could well spoil the Chancellor’s party on Budget day.”
