Invezz.com - Britain’s national debt has recently hit a critical threshold, reaching 100% of GDP for the first time in more than six decades.
As the country faces mounting financial pressures, Chancellor Rachel Reeves is gearing up for her first Budget on October 30, where she must address a rapidly deteriorating economic situation.
With public sector borrowing rising sharply, inflation pushing up costs, and debt servicing payments piling up, the UK is, quite literally, spending beyond its means. The scale of the challenge ahead is immense, and tough decisions are on the horizon.
How bad is Britain’s debt problem?
The latest data from the Office for National Statistics (ONS) reveals that Britain’s public sector debt has hit 100% of gross domestic product (GDP), a level not seen since the early 1960s when the country was still grappling with the financial consequences of World War II.
This milestone highlights how deeply embedded the UK’s financial troubles have become, driven by a combination of weak economic growth, high inflation, and substantial public spending.
In August 2024, the UK government borrowed £13.7 billion, £3.3 billion more than the same month in 2023, and £2.5 billion above forecasts made by the Office for Budget Responsibility (OBR).
Over the first five months of the 2024/25 financial year, the government’s borrowing totalled £64.1 billion, which is £6 billion higher than OBR projections.
This growing fiscal gap has triggered alarm across the political spectrum, with concerns that the country is on an unsustainable path.
Compounding the issue is the rising cost of debt servicing.
In August alone, debt interest payments reached £5.9 billion, only marginally lower than last year, despite the Bank of England beginning to lower interest rates after a prolonged period of high inflation.
These payments are tens of billions higher than what was anticipated before the Covid-19 pandemic, reflecting the abrupt end of the “low for long” interest rate environment that had eased the government’s borrowing costs for years.
Why is public spending spiraling out of control?
While the government’s tax revenues have increased, they have been far outweighed by escalating public spending, particularly on welfare benefits and public services.
Inflation has significantly raised the cost of running these services, while benefits like the carer’s allowance and disability living allowance have been adjusted to keep pace with rising prices.
As a result, the government is struggling to keep its finances in check.
These factors are putting immense pressure on Rachel Reeves, the Labour Chancellor, who is set to deliver a Budget in late October that many expect to be painful for the British public.
Reeves has already warned that tax hikes are unavoidable, but she has ruled out increases in income tax, corporation tax, and value-added tax (VAT), leaving her with limited options for raising revenues without breaking Labour’s manifesto commitments.
However, inflationary pressures continue to mount.
Not only are public sector wages being driven higher, but essential services are also becoming more expensive to maintain, pushing up overall government expenditure.
Reeves has already taken steps to reduce spending, such as scrapping the winter fuel payment for most pensioners and shelving planned investments in social care, infrastructure, and hospitals.
Yet, even with these cuts, there are widespread concerns that the country’s fiscal situation is becoming increasingly precarious.
Consumers don’t look too optimistic
As the government prepares for its next fiscal steps, consumer confidence is beginning to falter.
A recent report from data provider GfK showed a sharp decline in consumer confidence in September, the lowest since March, with many households fearing the effects of upcoming cuts and potential tax hikes.
Concerns about the loss of the winter fuel allowance, combined with the possibility of even higher energy bills, have left many Britons worried about their financial future.
Despite these warnings, some experts caution against overstating the public’s fear.
Retail sales figures, for instance, do not yet show signs of widespread consumer panic, suggesting that the full impact of the government’s economic measures may not have fully sunk in.
Still, with the October Budget looming and energy costs set to rise as winter approaches, sentiment could deteriorate further.
Can economic growth save the UK from financial disaster?
When it comes to managing high national debt, there are typically four options available, but only one of them is favorable.
The first option is to raise taxes, which puts a strain on households and businesses, potentially slowing down the economy.
The second is cutting public spending, which often leads to reduced services and welfare programs, affecting the most vulnerable in society.
The third, and least desirable, is printing more money, which can fuel inflation and destabilize the economy.
The only positive solution is fostering economic growth.
If the economy grows, the national debt becomes more manageable in relation to the country’s overall wealth, reducing the need for drastic fiscal measures.
Yet, economic growth in the UK has been sluggish.
The Bank of England recently revised its growth forecast for the third quarter of 2024 down to just 0.3%, a downgrade from the previous 0.4%.
The government’s focus on fiscal tightening, combined with weak consumer confidence and potential job losses, could further stifle growth in the months ahead, making the path to reducing debt even steeper.
Labour, despite its strong mandate following a recent election, has adopted a starkly negative tone on the state of the economy, warning of dire consequences if fiscal discipline is not restored.
While this approach may help Reeves prepare the public for painful decisions, some within the party worry that the messaging could backfire, undermining the government’s popularity before it even has a chance to implement its agenda.
Zooming out, the current fiscal environment in the UK represents a period of heightened uncertainty, but also opportunity.
In general, higher borrowing costs and volatile consumer sentiment might lead to short-term market dips.
However, this could also present buying opportunities for those with a longer investment horizon, especially if the government prioritizes infrastructure and innovation to stimulate growth.
The final months of 2024 will be critical in defining the direction of Britain’s economy.
This article first appeared on Invezz.com
