U.Okay. borrows billions greater than anticipated as debt prices surge

A surge in debt-interest payments sent the budget deficit to £20.7 billion ($27.9 billion), the Office for National Statistics said on Tuesday, £6.6 billion more than a year earlier and well above the £17.5 billion economists surveyed by Bloomberg expected. 

Borrowing in the first three months of the fiscal year was £57.8 billion, around £7.5 billion higher than a year earlier and in line with the forecast made by the Office for Budget Responsibility in March. The deficit had been running billions below official projections in April and May.

The level of borrowing leaves Reeves with a hole to fill in her autumn budget. Her fiscal plans have been knocked by recent U-turns over billions of pounds of spending cuts. There are also fears of a downgrade to official growth projections, leading many economists to warn that higher taxes are inevitable.

The chancellor is caught between febrile bond markets worried about government debt levels across advanced economies and rebellious Labour lawmakers who recently forced the government to pull back on reforms to welfare spending. Reeves has stood firm on her fiscal rules, which include a promise to fund everyday government spending with tax receipts by the end of the decade.

Gilts fell more than their German and US peers following the release, lifting the UK 10-year yield three basis points to 4.63%.

The deficit in June was boosted by a £16.4 billion debt-interest payment, the third highest for any month on record. The £8.4 billion surge from a year earlier was driven by a jump in inflation in April increasing the cost of servicing bonds linked to the Retail Prices Index, which make up a quarter of the total debt stock. However, this effect won’t be repeated in July, as the RPI barely rose in May.  

“Things will probably get worse for the chancellor,” said Alex Kerr, UK economist at Capital Economics. “We think that she will need to raise £15-25 billion at the Budget later this year, with higher taxes doing most of the heavy lifting.” 

The ONS said government receipts in June continued to be bolstered by the hike in employer payroll taxes that came into effect in April. Revenue came in at £86.8 billion, £5.7 billion more than a year earlier. Compulsory social contributions, which reflect the increase in national insurance contributions, were £48 billion for the first three months of the fiscal year, £7.5 billion higher than last year. 

However, it was more than offset by rising spending with government expenditure in June climbing £12.4 billion to £97.1 billion. Besides debt costs, spending was also boosted by higher outlays on welfare and public-sector wages.

Net debt stood at £2.9 trillion, or 96.3% of GDP, in June — around the highest levels since the early 1960s. A wider view of the public finances used for the chancellor’s fiscal rules, known as public sector net financial liabilities, came in at £2.5 trillion, or 83.8% of GDP.

The Bank of England’s upcoming decision on quantitative tightening will be one factor determining the fiscal outlook. The Treasury is having to stump up for losses related to the BOE’s bond operations that are running into the tens of billions of pounds. There has been speculation it will halt sales of long-dated debt after signs of fragility in that part of the market.