UK borrows less than expected in December but inflation erodes any gain

Public sector net borrowing stood at £16.8bn last month while debt interest payments hit £8.1bn

The Canary Wharf financial district of London. The UK's borrowing figures in December were boosted by more housing stamp duty and fuel taxes. Reuters

Britain’s government borrowed less than expected in December as the gap between spending and tax receipts hit £16.8 billion ($22.7bn), but surging inflation caused interest payments to jump to the second-highest level on record.

Public sector net borrowing in December was the fourth highest for the month as the cost of supporting the economy through the Covid-19 crisis continued, taking the shortfall for the nine months to December to £146.8bn, £13bn below forecasts from the Office for Budget Responsibility.

While the figures raised the prospect of extra cash for Chancellor of the Exchequer Rishi Sunak at a time when he faces pressure to ease the cost of living pressure on households and businesses before an increase in taxes comes into force in April, high interest payments eroded any political gain for him before the budget in March.

“Risks to the public finances, including from inflation, make it even more important that we avoid burdening future generations with high debt repayments,” Mr Sunak said.

“Our fiscal rules mean we will reduce our debt burden while continuing to invest in the future of the UK.”

While the borrowing figures were boosted by more housing stamp duty and fuel taxes, the data also pointed to a rising cost to the public finances as a result of inflation, which last month hit a 30-year high of 5.4 per cent.

Debt interest payments hit £8.1bn last month – the second highest on record, reflecting a sharp jump in retail price inflation, the peg for inflation-linked British government bonds which account for about a third of the total.

"Surging inflation is making [Mr Sunak's] task of returning the public finances to a sustainable footing much more difficult," said Samuel Tombs, an economist with Pantheon Macroeconomics.

Mr Sunak is facing calls to drop a planned increase in social security contributions for workers and employers, known as National Insurance, which is expected to raise £12.7 billion in the coming financial year.

He is also considering ways to help soften the impact of surging energy costs on households.

Laith Khalaf, head of investment analysis at AJ Bell, said money flowing out of the public sector continues to comfortably exceed the cash coming in.

Despite the high figure, the dials are generally heading in the right direction from the peak of the pandemic, although "not as quickly as the Chancellor might like", he said.

“Central government tax revenues rose by 10 per cent year on year, boosted by low levels of unemployment, even in the aftermath of the furlough scheme. Meanwhile expenditure came in lower than last December, but only just, because interest payments on government debt trebled compared to last December," Mr Khalaf said.

“That is because higher inflation has pushed up the cost of government bonds that are pegged to Retail Price Inflation, costing the government £5.5bn in December 2021. With price rises still coming down the track, inflation is going to continue to bump up the coupons paid by the government to holders of RPI-linked bonds, so this won’t be a flash in the pan.”

Interest rates are also on the rise and the Bank of England is widely expected to lift rates to 0.5 per cent next month, from the current 0.25 per cent, making the debt even more expensive.

“It means the government will have to pay more interest on the £875bn of gilts held with the BoE. And if that were not enough, gilt yields have shot up, to over 1 per cent on the 10-year bond, which means the government will also be paying more for freshly issued debt than before the pandemic,” said Mr Khalaf.

The data also showed that public sector debt, excluding public sector banks, stood at £2.34 trillion at the end of the month, or about 96 per cent of gross domestic product – the highest level since the 1960s.

"This means the chancellor is still wedged in a tight spot after the pandemic ravaged the nations finances," Mr Khalaf said.

Updated: January 25, 2022, 9:25 AM