Britain’s Debt Got Less Onerous—No Thanks to ‘Austerity’

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An old bogeyman returned to headlines Wednesday: UK deficits. July’s fiscal tallies hit the wires, showing borrowing jumped to £3 billion—miles above the Office for Budget Responsibility’s forecasts for just £0.1 billion in what is usually a quiet month.^[i] Naturally, this sparked another round of handwringing over what sort of “austerity” new Chancellor Rachel Reeves will unleash in October’s Autumn Statement, specifically tax hikes. This is a heated discussion, but 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.

This time last summer, a potential UK debt crisis was a hot topic. Interest payments were up, due largely to the UK’s relatively heavy use of inflation-linked bonds (known as index-linked Gilts, their version of Treasury Inflation-Protected Securities). Unlike fixed-rate debt, inflation’s impact meant higher interest payments immediately—not just when (and if) refinanced at more costly rates. With inflation rates still high, pundits projected ever-rising debt service costs would soon turn the UK into the next Greece.

At the time, we theorized that the UK could wiggle out of this without draconian austerity. Some of this would be the painful fruit of the country’s frozen income tax bands—which haven’t risen with inflation, sucking many more households into higher brackets and exposing more pension income to taxes. But GDP growth also looked likely to lift tax revenues in the happier way, while the maturation of high-paying index-linked Gilts would ease the acute interest burden.

As it happens, this has largely played out. Buried in most of the deficit report’s coverage was the observation that total UK public spending was up despite interest payments falling. 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. Friends, 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 defused itself.

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

Source: ONS, as of 8/21/2024. 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. 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 folks on low and fixed incomes hard. But rising nominal GDP growth helped. So did the recovery in real GDP that is now underway.

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

Source: ONS, as of 8/21/2024. 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. 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. Now, things look muuuuuuuuuuuch better. Interest costs were just 7.1% of revenues in July. You read that right—7.1%!

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

Source: ONS, as of 8/21/2024. 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, it is solid evidence that fast fears often resolve—and disprove—themselves much sooner than folks anticipate. This doesn’t always get headlines. It often gets buried. We haven’t seen anyone touting the UK’s much-improved fiscal standing. But 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 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. But even if Reeves opts for minor tweaks, UK public finances should be fine.