Chancellor Rishi Sunak faces an extra £10bn bill over the next two years as inflation surges drive up interest bills on government debts. Approximately a quarter of the government's £460bn debt is tied to the retail price index (RPI) measure of inflation, so the Treasury must pay out more money to savers and investors when prices rise.
The Office for Budget Responsibility in March predicted RPI inflation would peak at 3.1 per cent in the second quarter of this year. Prices in June were up 3.9 per cent on the year, and the index appears to be rising steeply. UK economists, meanwhile, predict the RPI rate of inflation will rise to 4 per cent or even more.
Senior economic advisor to the EY Item Club, Martin Beck was quoted in a Telegraph report as saying, “What had been a brighter outlook for the public finances now faces a threat from rising inflation and the risk that interest rates might rise sooner than expected. That said, the economic rebound should boost wages and profits, resulting in more money for the Government from taxes on workers and companies. And the jump in inflation, if it persists, would mean the Chancellor’s decision to freeze income tax thresholds in March’s Budget raises more money than expected.”
Jack Leslie, economist at the Resolution Foundation, meanwhile said it could have painful effects in the long-term as investors demand higher interest rates on bonds not linked to RPI. He said, “If inflation is higher in the longer term, that shifts up expectations of what nominal rates need to be when it comes to refinancing non-index linked bonds.”
A Treasury spokesperson said, “Inflation is one of a number of risks to the public finances that we closely monitor, and that’s why at the Budget in March the government set out the actions we are taking to ensure the public finances return to a sustainable footing.”