Britain’s Debt Got Less Onerous—No Thanks to So-Called Austerity

Editors’ Note: MarketMinder Europe prefers no politician nor any party. We assess developments for their potential economic and market impact only.

An old bogeyman returned to headlines we follow Wednesday: UK deficits. July’s fiscal tallies hit the wires, showing borrowing jumped to £3 billion—well above the Office for Budget Responsibility’s (OBR) forecasts for just £0.1 billion in what we find is usually a quiet month.^[i] Naturally, commentators we follow returned to speculating on what sort of austerity new Chancellor Rachel Reeves will unleash in October’s Autumn Statement, specifically tax hikes. This is a heated discussion, but in our view, it is a political discussion. If we are looking in pure economic terms—and therefore in market terms—the UK’s fiscal standing has improved greatly over the past year, as we will show.

This time last summer, a potential UK debt crisis was a hot topic amongst commentators we follow. Interest payments were up, due largely to a heavy use of inflation-linked Gilts, also known as index-linked gilts.^[ii] Unlike fixed-rate debt, inflation’s impact meant higher interest payments immediately—not just when (and if) Gilts are refinanced at more costly rates.^[iii] With inflation rates still high, commentators we follow projected ever-rising debt service costs would soon turn the UK into the next Greece.^[iv]

At the time, we theorised the UK could avoid this scenario without draconian austerity. Some of this would be the painful fruit of frozen income tax bands—which haven’t risen with inflation, sucking many more households into the Higher and Additional Rate and exposing more pension income to taxes.^[v] But based on our research, gross domestic product (GDP, a government-produced measure of economic output) growth also looked likely to lift tax revenues in the happier way, by raising the amount of taxable economic activity, whilst the maturation of high-paying index-linked Gilts would ease the acute interest burden.^[vi]

As it happens, this has largely played out. Most coverage we saw of the deficit report buried the observation that total UK public spending was up despite interest payments falling.^[vii] That caught our, um, interest! {Rimshot.} So we popped over to the Office for National Statistics (ONS), downloaded some data and refreshed the charts we showed you last year. In our view, the change is staggering.

The first shows the absolute amount and composition of central government interest payments on a trailing 12-month basis to smooth out monthly variances. Not only is it down nearly -£30 billion from last summer, but the inflation-linked contribution is now negative. Yes, the allegedly ticking timebomb appears to have defused itself.

Exhibit 1: Central Government Interest Payments (Trailing 12-Month Basis)

Source: ONS, as of 21/8/2024. Monthly central government interest payments and index-linked Gilt capital uplift, April 1997 – July 2024. Data shown on a trailing 12-month basis.

Meanwhile, government revenues are up.^[viii] Yes, bracket creep gets some of the credit for this, and we are acutely aware of the pain this inflicted on many households. Not only does it take a bigger bite out of people’s pay as their incomes slowly catch up to consumer prices, but it is exposing more pensioners to tax as their payments exceed the tax-free allowance (which is also frozen). This is another example of inflation hitting those on low and fixed incomes hard. But rising nominal GDP growth helped.^[ix] So did the recovery in real (inflation-adjusted) GDP that is now underway.^[x]

Exhibit 2: Central Government Total Current Receipts (Trailing 12-Month Basis)

Source: ONS, as of 21/8/2024. Monthly central government total current receipts, April 1997 – July 2024. Data shown on a trailing 12-month basis.

Combine rising tax revenues and falling interest payments, and what do you get? A steep reduction in the UK’s overall debt service burden, which we think is most helpful to measure as interest payments’ share of revenues. When last we checked in, UK interest costs were running at about 10.8% of tax revenues, which was down from the end of 2022 and in line with most of the booming 1980s, but still higher than at any other point since the late 1990s.^[xi] Now, we think things look much better. Interest costs were just 7.1% of revenues in July. You read that right—7.1%!^[xii]

Exhibit 3: Central Government Interest Payments as a Percentage of Revenues (Trailing 12-Month Basis)

Source: ONS, as of 21/8/2024. Monthly central government interest payments divided by total current receipts, April 1997 – July 2024. Data shown on a trailing 12-month basis.

This isn’t a we told you so. Rather, we find it is solid evidence that widely discussed perceived negatives like this often resolve—and disprove—themselves much sooner than many anticipate. In our experience, this doesn’t always get lots of attention. It often gets buried. None of the publications we follow are touting the UK’s much-improved fiscal standing. But in our view, markets often see these things and rise on the stealthy, subconscious relief.

Of course, we doubt this has much bearing on what Reeves will include in the Autumn Statement. Like we said, this is a political debate, and we find both sides of the ideological aisle tend to pass whatever they want to pass regardless of the economic facts. It is part of being a politician, in our view. But even if Reeves opts for minor tweaks, we think UK public finances will likely be fine.