Own Goals in Latest Budget Raise UK Inflation and Debt Interest Spending

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Own goals in HM Treasury's latest budget will add a percentage point to the inflation rate from April and force the taxpayer to cough up an extra £5 billion or more to cover the resulting increase in debt interest costs for the subsequent year even without any impact on Bank of England (BoE) interest rate policy.

The decision to cut back the energy price guarantee for households and to also raise fuel duty from April 2023 will have the effect of lifting inflation as measured by the consumer and retail price indices with automatic implications for future government spending including in relation to debt servicing costs.

Pound Sterling Live calculations suggest consumer price inflation will rise by an additional 1% in April as a result of these two things and that retail price index inflation will climb by 1.3%, leading to a knock-on increase of around £5BN in the cost of servicing borrowings that have interest rates linked to inflation.

"Higher RPI inflation adds £1 billion a year on average to the cost of index-linked debt, but with a very uneven path from year to year caused by the interaction between higher energy prices and the EPG [energy price guarantee] on the profile of RPI inflation," the Office for Budget Responsibility said on Thursday. 

The OBR estimates that changes to the energy price guarantee alone will lift consumer price inflation by one percentage point and that any matching increase in retail price inflation would raise government debt servicing costs by £6BN per year, meaning Pound Sterling Live's estimates may be too low.

Source: Office for Budget Responsibility.

Debt Management Office (DMO) figures show the government had issued £373 BN of so-called index-linked debts as of last Friday while also revealing that recent increases in inflation had already lifted the repayment value of these debts to £564.9 BN even before the latest budget.

Interest is paid twice per year on all government bonds but that paid by index-linked debts or so-called linker bonds mimics changes in the retail price index (RPI) inflation rate so the interest bill will increase as a result of attempts to reduce overall spending by scrimping on the energy price guarantee. 

The government had sought to cap the average household energy bill at £2,500 per year before the chancellor said last Thursday that this cap would rise by 20% to £3,000 from April, taking it closer to the current level of the Office for Gas and Electricity Markets (OFGEM) price cap of £3,500.

"With prices forecast to remain elevated throughout next year, this equates to an average of £500 support for households in 2023-24," the chancellor told parliament last week when announcing fiscal measures intended to reduce inflation and improve the public finances. 

The 'price cap' has risen from £1,277 in October 2021 and is the main driver of inflation that have risen to double-digit percentages in recent months. 

Source: Office for Budget Responsibility.