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The U.K. government doesn’t have much to fear from bond vigilantes and can afford to forget about fiscal restraint for now.
Chancellor of the Exchequer Rishi Sunak signaled the end of 10 years of austerity on Wednesday by announcing a £30 billion fiscal stimulus partly designed to counter the impact of the coronavirus outbreak. The independent fiscal watchdog the Office for Budget Responsibility called this year’s budget “the largest sustained fiscal loosening since 1992.”
It will increase the deficit and raise the level of public debt. But the U.K. can afford it, and shouldn’t worry about the country’s capacity to finance itself on the markets, for at least three reasons.
The first is that interest rates are at historic lows. Yields on the country’s 10-year bonds have fallen in the last two years along with those of most other European economies. The U.K. government was paying more than 1.5% in January 2018 to borrow over 10 years. It now pays little more than 0.2%, which amounts to a negative interest rate when taking into account the 1.4% inflation.
Yields on the U.K. 10-year gilts TMBMKGB-10Y, -26.78% haven’t moved significantly since Sunak’s speech on Wednesday, indicating that bond investors remain sanguine about the country’s announced stimulus.
The U.K.’s ratio of public debt to gross domestic product, at 85%, is in the current European average, at a midpoint between the 60% of frugal Germany and 100% in spendthrift France. It may rise slightly after the budget announcement, but as economist Olivier Blanchard has shown, public debt levels should stop being a concern when real interest rates fall below the growth rate. The OBR sees GDP growing 1.1% this year (before taking into account the coronavirus impact on the economy).
The second reason the U.K. shouldn’t worry too much financially is that the average maturity of its public debt is by far the longest among western economic powers. It is spread over 16 years. The country coming closest in Europe is France, whose debt maturity is about 8 years. For public finances, it is not the stock of debt that matters, but the annual payments — which are lower when debt maturity is longer.
Finally, the Bank of England holds a large portion of U.K. gilts, after its quantitative easing program that saw it acquire £435 billion worth of assets since the financial crisis. The BoE keeps reinvesting the money when the bonds arrive at maturity. The U.K. pays interests to the central bank on those, but that money doesn’t leave the public coffers.
According to the OBR, more than 20% of annual payments go to the BoE. That leaves the government paying out less than 2% of GDP in interest every year. It is not insignificant, but it is sustainable. A back of the envelope calculation suggests the £30 billion fiscal stimulus announced by Sunak on Wednesday will amount to a meager £140 million more annually in interest payments (including £30 million to the Bank of England) if spread over 15 years.
And that is not counting, more importantly, the overall economic impact of the stimulus plan, which will notably more than double public investment over the next five years, the think tank Institute for Fiscal Studies notes. If implemented correctly, the policy will help the U.K. to shorten the coronavirus impact and get back sooner on the growth path. That is money well spent, whatever the actual public debt level will be.
