The UK’s public finances are under considerable strain, with May’s borrowing figures revealing a substantial increase. The Office for National Statistics (ONS) reported that the government borrowed £23.3bn last month, marking a nearly one-third rise compared to the same period last year. This figure exceeded the Office for Budget Responsibility’s (OBR) forecast by £5.6bn, highlighting the fragile state of the nation’s finances.
The surge in borrowing was primarily driven by increased spending on debt interest, public services, investment, and benefits. Despite higher tax receipts, these expenses outweighed the additional revenue, pushing the borrowing figures to new heights. The OBR’s forecast, made in March, did not account for the economic impact of the war in the Middle East, which has since contributed to rising inflation and higher borrowing costs.
The Impact of Rising Debt Interest Costs
The interest payable on government debt reached a record high of £11.7bn in May, the highest ever recorded for that month. Analysts attribute much of this increase to higher inflation, which has been exacerbated by the conflict in the Middle East. Danni Hewson, head of financial analysis at AJ Bell, noted that long-term borrowing costs have been creeping up and will be closely monitored, especially if a Labour leadership contest ensues.
Susannah Streeter, chief investment strategist at Wealth Club, observed that investors seem to have priced in the likelihood of a Labour leadership challenge. Andy Burnham, who has been drafted in economic heavyweights to shore up his credentials, has pledged to follow existing fiscal rules, including not borrowing to fund day-to-day spending. His commitment to reducing welfare costs to fund higher defence spending signals a shift towards the political centre, which may provide some reassurance to investors.
Political and Economic Implications
The Bank of England’s decision to hold interest rates on Thursday reflects the delicate balance between a sluggish jobs market and expectations of further inflation. Chief Secretary to the Treasury Lucy Rigby emphasized that the war in the Middle East has had a global impact but asserted that the UK has the right economic plan to address these challenges.
Shadow Chancellor Mel Stride criticized the current government’s handling of borrowing, stating that it is “out of control.” He argued that the Conservatives are the only party with a plan to balance the books by controlling spending, particularly on the welfare bill. Meanwhile, separate figures showed that retail spending rose by 1.2% in May, boosted by unseasonably good weather and promotions.
The Potential Impact of a Labour Leadership Change
City economists and analysts are concerned that UK government borrowing costs could rise if the Labour Party holds a leadership race this summer. Dan Coatsworth, head of markets at AJ Bell, suggested that gilt yields could keep rising if Keir Starmer does not step down quietly. The yield on UK 30-year bonds has already increased by 8 basis points to 5.529%, reflecting these concerns.
Alexandros Xenofontos and Christopher Granville at TS Lombard noted that gilts are constrained by the return of domestic political risk. Neil Wilson, investor strategist at Saxo UK, observed signs that markets are already worrying about the outcome of the Makerfield by-election, which could lead to Andy Burnham becoming Prime Minister and a potential leftwards shift in government policy.
The macroeconomic backdrop has changed since early May, with market angst over inflation elevated and expectations of multiple rate hikes by the Bank of England. However, the market remains sensitive to how Andy Burnham might steer Labour in a different direction if he replaces Keir Starmer. The potential for a snap general election adds another layer of complexity to the situation.
The outcome of any potential Labour leadership contest and the policies of the next Prime Minister will be crucial in determining the nation’s fiscal future.
