Britain is slipping closer towards a devastating debt spiral

Telegraph

12 hours ago

Every year, the Office for Budget Responsibility (OBR) produces a so-called Fiscal Risks and Sustainability report, and every year the warnings of impending disaster in the public finances get ever more blood-curdling.
Here are a few statistics to give the measure of the mess we are in.
The ongoing fiscal deficit is the third highest in Europe and the fifth highest out of all advanced economies tracked by the OECD. The debt-to-GDP ratio looks equally alarming; it's the fourth highest in Europe and the sixth highest in the OECD group of higher-income economies.
But what should really have us all reaching for the panic button is Britain's cost of borrowing. At 4.6pc, the yield on UK 10-year government bonds – gilts – is the highest out of all the advanced economies bar New Zealand and Iceland.
Yes, higher than Greece, higher than Italy and higher than all the other one-time fiscal basket-cases collectively known during Europe's sovereign debt crisis 15 years ago as the Piigs (Portugal, Ireland, Italy, Greece, and Spain).
A classic vicious cycle of rising indebtedness and debt servicing costs is threatened, otherwise known as a debt spiral. The point of no return is approaching fast.
Labour's seeming inability to confront the hard choices on tax and spend has further unnerved investors, ratcheting up the premium they demand for lending to the UK.
The higher interest rates needed to support debt issuance are in turn beginning to crimp growth, making it harder still for the Government to escape the resulting debt trap.
Rachel Reeves, the Chancellor, is reportedly planning a series of meetings with backbench MPs to impress on them quite how perilous the UK's position has become.
Good luck with that. With a Prime Minister as spineless as Sir Keir Starmer, the leadership needed for the required surgery is almost entirely lacking.
Already he's forced the Chancellor into a humiliating retreat on efforts to reduce welfare spending and axe the winter fuel allowance.
To be fair, inability to face up to reality is by no means confined to Sir Keir. His Tory predecessors were just as bad. In their desperation to get re-elected, they were equally guilty of reversing planned tax rises and abandoning promised spending cuts.
Persistent fiscal deficits have been accommodated only by successive loosening of the fiscal rules.
Nor does Reform UK on current form offer any kind of credible alternative. Its platform of fantasy tax cuts financed by equally undeliverable reductions in spending is pure snake oil - worse in some respects than Sir Keir's promise not to raise taxes on working people.
In any case, they've all got their heads buried in the sand.
The OBR can warn all it likes of impending disaster, but it has no teeth in highlighting the fiscal mire into which Britain is sinking.
Beyond a few 'here today, gone tomorrow' headlines, its alerts are mostly ignored.
If the political class can't or won't act voluntarily, the required adjustment will eventually be much more painfully forced on the nation by bond markets and/or the conditionality attached to an International Monetary Fund (IMF) bailout.
The UK is on a slippery slope from which retreat may already have become impossible.
That the events of 1976 – when the then-chancellor Denis Healey was forced by a sterling crisis to go 'cap in hand' to the IMF for an emergency loan – might in some way be repeated no longer seems entirely fanciful. Back then, debt was still less than 50pc of GDP; today it is nearly 100pc.
As a proportion of sovereign debt, Britain has more in the way of index-linked bonds than any other advanced economy. Falling inflation should therefore bring some relief to debt servicing costs. Sadly, it is likely to be temporary.
Debt issuance in the UK faces a particular problem, which most other advanced economies don't have, in that one of the major sources of domestic demand for gilts – final salary pension schemes – is drying up.
Britain's big, defined benefit pension funds have in the past been substantial buyers of gilts for liability matching purposes, but with the vast bulk of them now closed and essentially in run-off, they are being transformed from net buyers to net sellers.
Projections by the OBR suggest that total pension fund holdings of gilts as a share of GDP are likely to fall by around two thirds over the next 45 years from 29.5pc to just 10.9pc.
Outside the public sector, very few employees these days have access to defined benefit pension arrangements. Instead, we are shunted into 'defined contribution' pensions where the investment risk is borne by the individual.
These funds have far less appetite for gilts, but tend instead to be invested more heavily in equities and other higher risk assets.
Pensions freedom, relieving retirees of the one-time obligation to buy an annuity with their pension pots, has further skewed the field away from gilt investment towards equities.
On balance, this ought in the long run be better for the economy. Poor levels of business and infrastructure investment in the UK are strongly linked to the in-built bias among pension funds in favour of gilts over companies and other productive assets.
But what may eventually prove good for the economy is not at all good for the gilts market.
The OBR calculates that the decline in pension sector demand for gilts could push up interest rates on government debt by around 0.8 percentage points, assuming the stock of debt remains close to 100pc of GDP.
By making the Government more reliant on price-elastic buyers such as overseas investors, the UK also becomes far more vulnerable both to global trends in interest rates and any sudden loss of confidence in the country's ability to manage the public finances in a sustainable way.
The other big recent source of demand in the gilts market was the Bank of England through its 'quantitative easing' asset-purchase programmes. But with 'quantitative tightening' this has now gone strongly into reverse.
All of a sudden, the UK Debt Management Office finds itself up the proverbial without a paddle. It's true that other countries – notably Japan, the US, Greece, Italy and France – would on the face of it seem even more fiscally stretched than the UK.
But Japan has a massive domestic savings surplus to sustain its ever higher levels of debt issuance, while the three European miscreants are in effect underwritten through monetary union by the German credit card.
As for the US …well, it remains a major draw for international capital, despite its quite plainly unsustainable fiscal profile.
There are no such safety nets to support the UK. Bullies tend to pick on the weakest, and the international bond market is perhaps the biggest bully of the lot.
For choice, Labour would raise taxes to fill the gap, but with public services still on the slide, it's a hard sell to voters who not unreasonably expect better from their taxpayer pounds. A reckoning is coming; it's only a question of when.