UK: Public borrowing is surging, but no cause for fiscal alarmism yet

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● Big shock = big debt: The Office for Budget Responsibility’s (OBR) new economic and fiscal projections, published alongside Chancellor Rishi Sunak’s detailed two-year spending plans, highlight the huge costs of the pandemic and ensuing mega recession. The OBR’s projections help to guide UK fiscal policy decisions. Following a surge in public sector borrowing to 19% of GDP in 2020 from 2.5% last year, the OBR projects that debt will increase by 200pt to 105.2% of GDP in 2021 before peaking at 109.4% in 2023 and edging down thereafter. Reacting to the projected debt surge, fiscally hawkish Conservative members of parliament as well as some senior civil servants are apparently urging the government to begin – perhaps as soon as the next budget in March 2021 – a period of austerity to reduce debt and balance the public sector finances.

● The case for doing nothing yet: In its central scenario the OBR projects that the UK will return to its pre-pandemic level of GDP by Q4 2022, before growth settles at a trend rate of around 1.7% by the middle of the decade. This is roughly in line with our base case. Based on the central scenario, the OBR estimates that public borrowing will settle at around 3.9% of GDP by 2024 once the UK returns to full employment – compared to the pre-pandemic estimate of 2.2%. The range around this call is wide, with borrowing falling to sub-2% in the OBR’s upside scenario and staying above 6% in its downside scenario – see chart. While the downside scenario looks scary, it remains less bad than the severe hit from the global financial crisis of 2008/09, which opened up a gaping structural deficit that needed to be corrected by a painful fiscal correction. Between 2008 and 2012 public borrowing averaged 8.1% of GDP.

● The UK is not alone: All major advanced economies are borrowing to the hilt to finance their health and economic policy responses to the virus. With the help of aggressive liquidity support by central banks, financial markets remain calm about potential debt risks. In the UK and elsewhere, government borrowing costs are at or near record lows. Some commentators correctly observe that a sudden surge in inflation expectations could push borrowing costs higher. While this is not impossible, the UK is less exposed to such a risk than other comparable economies. The average maturity of the stock of UK public debt is around 15 years, compared to around six years for the US, seven years for Germany and eight years for France and Japan.

● Borrow more if necessary: The benefits of spending aggressively to finance job and income support as well as public investment programmes, at a time when economic output is more than 10% below normal, far outweigh any distant risks that could materialise from the ongoing rise in public debt. Today, Chancellor Sunak did not announce any significant new measures that could improve the economic outlook materially. But this is not a major problem as the government is already providing aggressive support through its emergency pandemic measures such as the Job Retention Scheme, tax cuts/deferrals and generous credit guarantees. If the upswing begins to falter, the government would probably react by spending even more to stimulate demand until income and employment recovers.

● A risk to watch: Judging by the tone of the ongoing UK fiscal debate, the bigger risk to worry about is not that the government overdoes the stimulus, but that it falls short of an adequate medium-term response because deficit hawks persuade it to pull back policy support prematurely. As part of our recent upgrades to the UK economic outlook, we highlighted the risk of an unnecessary fiscal tightening. After five years of crippling Brexit uncertainty and a badly handled pandemic, the UK would do well to avoid another serious policy error.

Kallum Pickering

Senior Economist

+44 20 3465 2672

kallum.pickering@berenberg.com

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This material is intended as commentary on political, economic or market conditions for institutional investors or market professionals only and does not constitute a financial analysis or a research report as defined by applicable regulation. See the "Disclaimers" section of this report.

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