OBR’s message to Sunak is stark about Covid’s nasty legacy

Analysis: government’s spending watchdog’s report will be worrying reading for the chancellor

Last modified on Tue 6 Jul 2021 13.23 EDT

The message from the government’s spending watchdog to the Treasury and the Bank of England was stark: emergency action to cope with the biggest contraction in the economy in almost three centuries has consequences, none of them pleasant.

Each year the Office for Budget Responsibility – the independent body set up by the then chancellor George Osborne in 2010 to monitor the state’s finances – publishes a report on the perils ahead.

This year there was more than enough for the OBR to get its teeth into, so it homed in on three risks.

The headline grabbing figure was the £10bn that will need to be found to cope with the legacy costs of the pandemic: the money that will be required for health, education and transport. The continuation of test and trace, reducing NHS waiting lists, helping pupils to catch up on the schooling they have lost, and making up the shortfall caused by lost passenger revenue will not come cheap. Rishi Sunak will have some difficult decisions to make.

The second big fiscal risk is the cost of the government’s pledge to reach net zero carbon emissions by 2050. Phasing out petrol and diesel vehicles involves a loss of revenue from fuel duties. The government will need to help poorer households replace gas boilers. Even taking into account the revenue gain from carbon taxes, the OBR estimates that moving to net zero will add 21% of GDP to public debt over the next 30 years. But, as it pointed out, the cost of doing nothing and letting climate change rip would be even more costly.

In a sense, the final risk is the one that will concern Sunak most: the vulnerability of government debt to rising interest rates. For the past decade, the UK has been able to finance its debt cheaply because official interest rates have collapsed from 5% to 0.1%.

But public debt is now three times higher than it was before the financial crisis; the Bank of England’s quantitative easing programme has meant the UK now has a greater proportion of short-term liabilities that would be more costly were interest rates to rise; and a bigger share of debt is now owned by international investors.

The threat is obvious. By law, the Bank has an obligation to hit the government’s 2% inflation target. In the event that rising price pressures forced Threadneedle Street to raise interest rates sharply, debt servicing would become a lot more costly.

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