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Treasury on course to spend 10% of government revenue on bond costs this year, according to Fitch

The UK is on track to incur the highest debt interest costs in the developed world this year as persistently high inflation and an unusually large proportion of government bonds linked to price rises damage the public finances.

The Treasury will spend £110bn on debt interest in 2023, according to a forecast by Fitch. At 10.4 per cent of total government revenue, that would be the highest level of any high-income country — the first time the UK has topped the data set that goes back to 1995.

Roughly a quarter of UK government debt is in the form of so-called index-linked bonds, whose payouts fluctuate in line with inflation, making the country a huge outlier internationally. Italy has the next highest share with 12 per cent of its bonds tied to inflation, while most countries have less than 10 per cent.

“We’ve had a very large inflation shock which is adversely affecting the public finances and that is obviously a key driver of the sovereign credit rating,” said Ed Parker, global head of research for sovereigns and supranationals at Fitch.

The agency reiterated in June its negative outlook on the UK’s double A minus credit rating, citing “the UK’s rising government debt and uncertain prospects for fiscal consolidation”.

Parker said a negative outlook signals that a downgrade is “more likely than not if current trends continue” and that the agency would normally hope to clarify a negative outlook within two years.

Debt interest costs as a proportion of revenue are a key measure of debt affordability and have jumped in the UK in the past couple of years while coming down elsewhere.

The UK will sit at the top of the Fitch debt interest costs table after its ratio increased dramatically in the past two years from an average of 6.2 per cent between 2017 and 2021.

In contrast, the average among western Europe and North American countries is set to fall from 4 per cent in the five years to 2021, to 3.7 per cent this year, as inflation has boosted government revenues and in some countries the debt expiring had higher interest rates than new debt issued.

Rising debt costs in the UK come as inflation proves harder to tame than in other developed economies, despite recent signs of improving data. The UK’s retail price index, which guides index-linked gilt interest payments, rose 10.7 per cent in the year to June, while wage inflation has yet to show signs of easing.

Fitch forecasts the UK’s debt interest-to-revenue ratio should start to fall next year as inflation continues to ease, with the interest burden of both the US and Italy set to overtake the UK in 2024.

However, rating agencies expect the UK’s interest costs to stabilise at historically high levels. “We expect the debt affordability of the UK to remain relatively weak” said Evan Wohlmann, a senior credit officer at rival rating agency Moody’s.

“Debt affordability is at risk from more persistent inflation as well as from a potential sustained erosion of the UK’s policy credibility,” he added.

Moody’s, which has an Aa1 rating on the UK — it’s second highest level — also has a negative outlook, a position it has held since October and expects to clarify within 12 months.

Concern among rating agencies on the UK’s credit outlook comes after the Office for Budget Responsibility, the UK’s fiscal watchdog, warned that public finances were in a “very risky” position, with government debt on course to hit 310 per cent of gross domestic product in 50 years.

The OBR said that the UK was “more vulnerable” than other advanced economies when it came to public debt, which in May surpassed 100 per cent of gross domestic product for the first time since 1961.

The government plans to sell £241bn of gilts in the current financial year, a sharp increase from £139.2bn issued in the previous 12 months, with issuance net of Bank of England bond purchases and sales expected to be about three times more than the average over the past decade.

Swedish group Vattenfall suspends Norfolk Boreas offshore project, which was set to power 1.5mn homes, due to surging costs

UK efforts to boost renewable energy have suffered a major setback after one of the country’s biggest offshore wind farm projects was halted due to surging costs.

Swedish energy group Vattenfall on Thursday said it had suspended development of its 1.4GW Norfolk Boreas wind farm after costs on the project rose 40 per cent.

Increased cost was putting “significant pressure on all new offshore wind projects”, the company said, adding that it would “not take an investment decision now” on the project and would book an impairment charge of SKr5.5bn ($537mn).

“What we see today, it simply doesn’t make sense to continue this project,” said Vattenfall’s chief executive Anna Borg.

The UK government is seeking to more than triple offshore wind capacity by 2030 — from about 14GW to 50GW — to help decarbonise the country’s electricity system.

Norfolk Boreas had been one of the biggest new projects in the offshore wind pipeline, set to help power 1.5mn homes. The wind farm was due to be the first of three to be built by Vattenfall in the UK on the east coast, to power more than 4mn homes in total.

The wind industry has warned over the past few months that rising interest rates along with turbine and labour costs have been putting UK projects at risk.

The British government last year awarded the Norfolk Boreas project a contract guaranteeing a fixed price of £37.35 per megawatt-hour for its electricity for the first 15 years, in 2012 prices and linked to inflation. Ministers celebrated a sum that was well below the ones agreed in previous years.

However, developers have argued that surging costs linked to supply chain problems in the wake of Russia’s full-scale invasion of Ukraine mean the projects may no longer be economically viable under these terms.

Vattenfall’s announcement is likely to heap pressure on the government, which is in the process of awarding the next round of fixed-price contracts. Developers have already warned that the maximum price of £44/MWh in 2012 prices is also too low.

Mads Nipper, chief executive of Ørsted, the world’s largest offshore wind developer, told the Financial Times last month that it was “inconceivable” that UK projects were not struggling.

The other two Vattenfall projects may be able to get higher government contracts, meaning they could still go ahead, Borg said. “We will now look into the situation and find the best way forward for all these projects — the energy is desperately needed,” she said.

Prime minister appears to water down his ambition to ‘stop the boats’ as he claims some successes

Rishi Sunak has said the situation with migrants crossing the Channel in small vessels to the UK is likely to get worse before it gets better as he appeared to water down his ambition to “stop the boats”.

The prime minister said on Tuesday that “crossings will increase over the summer”, when migrants tend to take advantage of more moderate weather to make the dangerous journey. But he insisted to journalists, while en route to the Nato summit in Vilnius, that the plan was “starting to work”.

In January, Sunak pledged to “stop the boats” crossing the Channel, making it one of his five key pledges ahead of the general election that is expected next year. However, he simultaneously cautioned that the challenge was not something that could be “fixed overnight”.

Asked whether he would consider his policy a failure if the number of crossings did not fall by the end of the year, Sunak said it was important to measure success against the “trajectory of increases taking place year over year”.

He added that the fact that the numbers making the journey were down for the first five months of the year was a “much better result than anyone was expecting”.

He was speaking after nearly 1,700 people made the journey on 31 boats between Friday and Monday, including almost 700 on Friday, the highest daily record this year, according to the Home Office.

In the first six months of this year, the number of people arriving in small boats decreased by 10 per cent, to 11,433, compared with the same period last year, although immigration specialists cautioned at the time that poor weather may have skewed the data.

Asked to provide clarity on Sunak’s pledge on small boat migration and what target he had set himself, a government official said the prime minister was not being prescriptive about what “stop the boats” means.

“It will be for the British public to judge whether the government has done everything it can within its power to stop the boats,” they said.

A surge in the number of people arriving over the past few days is threatening to undermine the narrative that the government’s policies have acted as a deterrent. Last year, nearly half of all people who made irregular Channel crossings arrived in July, August and September.

Despite figures showing an increase in crossings over the past few days, Sunak pointed to other areas where government policy was working, including reducing the backlog for dealing with asylum applications by a fifth and in finding accommodation for those that do arrive in Britain.

“There are a range of things we need to do to fix this problem — we need to get people out of hotels, we need to save taxpayers billions of pounds, we need the backlog down and processed,” he said.

The prime minister’s comments came as the government’s illegal migration bill has returned to the House of Commons after it suffered severe opposition in the House of Lords last week, where peers proposed 20 changes to the legislation.

Speaking in the House of Commons on Tuesday, Robert Jenrick, immigration minister, said the Lords had peppered the bill with “exceptions and get-out clauses,” that would neutralise its impact.

“The bill as passed by this house made it unambiguously clear to illegal migrants and people smugglers alike that if you come to this country by illegal means you will not be able to stay.”

With a few exceptions, he said, the changes made in the Lords were “little short of wrecking amendments”.

Responding, Stephen Kinnock, Labour’s shadow immigration minister, described the government’s whole approach to the small boats crossings, in particular its stalled plans to deport asylum seekers to Rwanda as an expensive and “shambolic farce”.

The debate also drew fierce comment from former prime minister Theresa May who said that unless changes made in the Lords are retained, the bill will undermine the modern slavery act she introduced and tie the hands of the police.

“It will consign more people to slavery — no doubt about it,” she said.

Chancellor wants to offer about 6% without having to increase UK borrowing

Jeremy Hunt has ordered ministers to find over £2bn of savings to fund 6 per cent public sector pay rises this year, as he prepares to hold crunch talks with Rishi Sunak on the matter.

The chancellor has warned that he will not borrow more money to fund pay rises for police officers, teachers, nurses and other public sector workers, arguing it would fuel consumer price inflation, currently running at 8.7 per cent.

Independent pay review bodies have recommended public sector awards of about 6 per cent for the 2023-24 pay round, well above the 3.5 per cent proposed by the government, creating a funding gap.

Hunt’s edict has provoked a flurry in Whitehall to find savings, including reviewing capital programmes, with warnings from some ministers that the cuts would damage already-stretched public services.

“The conversations are live and the bleeding stumps are out,” said one person close to the negotiations, referring to the habit of spending ministers to issue dire warnings of the consequences of cuts.

Hunt and Sunak are expected to agree a strategy on public sector pay on Thursday after the prime minister returns from the Nato summit in Vilnius, government insiders said.

New data on Tuesday showed that pay in the UK grew faster than expected and hit a record high in the three months to May, adding to pressure on the Bank of England as it tries to curb inflation.

Employees’ regular average pay, which excludes bonuses, grew at an annual rate of 7.3 per cent in the three months to May, higher than the 7.1 per cent forecast by analysts polled by Reuters.

Sunak and Hunt agreed to discuss the government’s response to the pay review bodies after digesting the new data, which has heightened official concern about wages fuelling inflation.

Hunt told the Financial Times last week that the pay review process, which covers 2.5mn public sector workers, was a good one, adding: “We would want to go along with it in all but the most exceptional circumstances.”

But he added: “If they’re funded in a way that puts additional demand into the economy at a time when there’s already too much demand, that only makes the battle against inflation harder.”

Those briefed on the Whitehall negotiations said ministers have been asked to find savings of between £2bn-£3bn to fund the pay awards, to avoid the need for extra government borrowing.

Hunt and Sunak will also have to weigh whether 6 per cent pay rises for teachers, nurses, doctors, dentists, prison officers, the police, armed forces and senior public officials is responsible in a high-inflation environment.

Ministers have previously warned that public sector pay deals set a template for the corporate sector, but government insiders said “the main transmission mechanism” to higher inflation was through more borrowing.

In any event, from March to May 2023 average regular pay growth for the private sector was 7.7 per cent, compared with 5.8 per cent in the public sector.

Governments rarely reject the recommendations of the pay review bodies; doing so this year would only heighten tensions with public sector workers who are conducting a wave of strikes in protest at last year’s awards.

On Monday, both Hunt and Andrew Bailey, Bank of England governor, warned at the annual Mansion House dinner in the City of London about the inflationary impact of high pay settlements.

Sunak told reporters en route to Vilnius that he was determined to hold down borrowing, partly because interest rates were rising — pushing up government debt costs — and partly because it would fuel inflation.

“Government should not fuel the fire by excessively borrowing at a time when that would make the situation worse,” he said, adding that tax cuts were off the agenda for now.

“The number one priority right now is to reduce inflation and be responsible with government borrowing,” he said. “That takes precedence over everything else.”

Meanwhile, the IMF, in a review of the UK economy, said on Tuesday that the country was “expected to avoid a recession in 2023” but there were “considerable risks in the period ahead”, including on pay.

Our public services are not the envy of the world and Whitehall reform is desperately needed

Robert Shrimsley

Britain may not be broken, to borrow an opposition slogan, but it is badly managed. Contrary to national myths, its civil service is not a Rolls-Royce institution and the NHS, its 75th anniversary marked with a church service, is not the envy of the world.

There are two overarching themes behind the malaise — money and management. The first is well understood: the demands citizens now make of the state exceed their readiness to pay for them. Without sustained economic growth or a sudden enthusiasm for tax rises, the squeeze can only tighten.

These constraints are focusing minds on the second point. The inertia of the permanent civil service lies at the root of frustration but reforming the machinery of government is unrewarding territory for politicians. Debate is often reduced to oafish calls for a purge on “pencil pushers”. And yet, for all the many fine officials, the poor management of the state is a block on ambitions and will be even more keenly felt as politicians grapple with the challenges around AI.

In 2020, Michael Gove, (opens a new window)then cabinet office minister, led calls for a more effective state, lamenting: “Of the 108 major programmes for which government is responsible, only eight per cent are assessed to judge if they have been delivered effectively and have brought about the desired effects.” But the impetus for change was lost amid the demands of Brexit and the pandemic.

Tory criticisms have been fuelled by Brexit rows but cannot be dismissed as simply the smears of snarling Leavers. Successive governments have shared frustration at the slow pace of delivery, seeking new ways to drive change from the centre. Tony Blair established a delivery unit, more recently attempts to build a prime minister’s department have foundered. Kate Bingham’s success, coming from outside Whitehall to run the Covid vaccine task force, was also a lesson for those resisting change.

This week sees the latest effort as Francis Maude, former Tory cabinet minister finalises his civil service review. Arguing that ministers are responsible for delivery but have too little power to effect it, he is likely to call for a beefed-up civil service regulator to hold departments and top officials to account for meeting core tasks.

He will recommend giving ministers more say in senior appointments. Critics worry about creeping politicisation and fear the move will leave officials fearful of offering unwelcome advice. Maude argues it will advance talent, build more “robust” debate and that departments must not be “neutral” about implementing a government’s programme. Some expect him to suggest splitting the roles of cabinet secretary and head of the civil service, leaving the former to focus on strategic priorities.

But reform must go deeper. Every decade brings a new plan for change, each a testimony to the failings of its predecessors. The critique remains the same: too many lifers and generalists, and a career structure that breeds groupthink. Whitehall needs more technologists, project managers and data scientists.

In 2020/21 around 18 per cent (opens a new window)of new entrants to the senior ranks were external hires. But Maude talks of the “tissue rejection” often felt by outsiders. The service struggles to recruit specialists. Salary is a major deterrent. One ex-minister notes that in areas such as AI, Whitehall might offer £70,000 to people whose expertise can command 10 times that in the private sector. Maude speaks approvingly of Singapore’s model but its salaries are very high. Paying more for great civil servants — for any public servant — is an argument politicians are loath to make.

The NHS, the UK’s largest employer, is also grotesquely undermanaged, a point emphasised in a recent paper by Sam Freedman and Rachel Wolf(opens a new window). It notes that Britain spends less than half the OECD average as a proportion of GDP on management and administration of the NHS. Health reforms veer wildly between operational independence and more top-down targets. There are good people at the top but unit managers are too often driven by demands from Westminster rather than local needs. The NHS must respond to the opportunities offered by AI and vast data troves, yet many doubt it has the people to lead this revolution.

There is, however, one other point of failure — weak ministers. Prime ministers will inevitably have to manage rivals and balance factions but too many people are being appointed to jobs for which they are ill-suited. Many have no experience of management, or lack the knowledge to challenge advice while the political carousel sees many move before they acquire it. Politicians are too quick to reach for micromanagement and headline-grabbing gimmicks.

Change also requires an end to the noxious Tory attacks denigrating civil servants as “the blob” and scapegoating officials when ill-considered policies collide with reality.

If all this were easy, it would have happened. Culture change is slow and hard and there are always more urgent priorities but the consensus for reform grows. There is, of course, waste to trim but good management is also expertise; a case must be made for spending on quality leaders and specialists.

As government becomes more complex, the need for reform has never been more apparent. From politicians to officials to public services, the management of the state is struggling to meet the needs of the nation.

Ofgem proposes reform after finding some power station owners held back supplies to secure higher prices

The British energy regulator has accused power station owners of trying to game the system for excess profits, as it set out steps to try and clamp down on the practice.

Ofgem said on Thursday that an investigation had found some generators had withheld supplies in order to fetch a higher price for them in the back-up market, pushing up costs for consumers at the height of the energy crisis.

It launched the probe after the costs of keeping supply and demand matched through the so-called balancing market hit record levels in November 2021 at the start of the energy crisis, with £60mn spent by network operator National Grid on one day alone.

Ofgem said those costs during the winter of 2021-22 — when demand is highest — hit £1.5bn, more than triple the level of the average over the preceding three winters.

The watchdog said it would crack down on “various behaviours it had identified among some generators, who have been attempting to gain excessive financial benefit at a cost to consumers”.

It is proposing a new licence condition to “ensure electricity generators don’t take advantage of existing rules to make excessive profits”, said Eleanor Warburton, Ofgem’s acting director for energy systems management and security.

The new licence condition, which will restrict generators’ ability to profit and include financial penalties for breaches, could be in place in time for winter, Ofgem said.

The intervention comes after UK chancellor Jeremy Hunt earlier this week stepped up the pressure on regulators, including Ofgem, to do more to keep consumer costs down.

Ofgem said: “We believe it is necessary to intervene to prohibit behaviours that result in generators realising excessive benefits, which are costs ultimately payable by consumers.”

The watchdog did not name the companies involved. However, an investigation by Bloomberg earlier this year said some traders at firms including Vitol, Uniper and SSE would tell National Grid they were shutting down power plants ahead of periods of tight supply only to start them up again once they had secured higher prices for the power.

Electricity supply and demand has to be constantly matched to avoid blackouts. National Grid smooths out any mismatches, using the “balancing market” to pay generators to switch on or turn off at short notice.

Ofgem said it identified “repeated instances” of generators telling National Grid they were going to switch off, and then offering to turn back on at higher prices in the “balancing market”, which the network operator has little choice but to accept. SSE said it “fully complies” with the rules. Vitol declined to comment but had previously said its VPI power business abided by “all relevant regulations and fulfils any commitments to deliver power to the grid”. Uniper did not immediately respond to a request for comment.

Adam Bell, head of policy at energy consultancy Stonehaven, said Ofgem could in theory ask generators to return some of the excess profits earned through the balancing mechanism, but it had little enforcement power beyond that.

“What they’re alleged to have done was within the letter of the rules, even if not in the spirit of the rules,” he said.

Darren Jones, Labour chair of the business and trade select committee, said: “This is another example of company executives getting away with immoral profiteering. But as immoral as it is, it isn’t illegal. Ministers will decide if that’s acceptable or not.”

The proposed change to the licence conditions would limit the prices generators charge in the balancing mechanism to their costs “plus a reasonable profit”.

Bell warned that while reforms to the market may be necessary there was the risk that Ofgem’s proposals could lead to companies being less able to offer energy supplies when needed.

“The people primarily at fault here are clearly the ones that were gaming the system but it’s not a straightforward issue to solve,” Bell said. “There will almost certainly be some legitimate behaviour that will also be removed by these proposals.”

Energy UK, the trade group, has previously said there was disagreement among generators over whether to support the licence condition, with some concerns that it could distort the market and damage investment.

The energy department said it welcomed all actions taken to protect consumers and backed Ofgem in using all the powers at its disposal to go further if needed.

Party officials are conferring with sister parties around the world for strategies on winning elections

President Joe Biden rolled out the red carpet for Rishi Sunak in Washington this month, but behind the scenes senior figures from Britain’s Labour party were also in town, covertly reinforcing links with leading Democrats.

The talks, which Labour tried to keep quiet to avoid embarrassing Biden during the UK prime minister’s visit, are part of an effort by party leader Sir Keir Starmer to learn from the Democrats and other centre-left parties on how to win an election.

One meeting saw Morgan McSweeney, Labour’s campaign director, discussing policy with Neera Tanden, director of Biden’s Domestic Policy Council, according to two people briefed on the discussions.

Starmer’s media chief Matthew Doyle was among those attending talks in Washington in early June, which also involved officials from centre-left parties from Australia, New Zealand and other countries.

Some Starmer allies believe their party has a lot to learn from US Democrats as Labour tries to win back working class voters in the north of England and Midlands.

“With the amount of money they have in their system, they are way ahead of us in terms of targeting the rustbelt, the level of data they have — some of their polling and messaging techniques are way ahead,” said one member of Starmer’s shadow cabinet.

“They have done a lot on how you can talk about the green transition and link to jobs in a way that works in the rustbelt.”

The meetings in Washington centred on two days of events organised by the Center for American Progress, a liberal think-tank, and its sister organisation CAP Action.

One Labour official briefed on the meetings said they were “all organised well before it was known that Sunak would be coming to Washington. It’s a coincidence.” The party declined to comment.

The high level talks are sign of a developing alignment between Biden’s Democrats and Starmer’s Labour party, with both party leaders facing elections next year.

US elections take place on November 5, 2024, while Sunak is expected to call a vote in either the early summer of next year or — more likely — the autumn. In the latter scenario, US and UK elections could run concurrently.

Last month Rachel Reeves, Labour’s economics spokesperson, held talks in Washington with Biden administration figures, including Treasury secretary Janet Yellen, and gave a speech warmly endorsing “Bidenomics”.

The Democrats and Labour have long considered themselves sister parties; in the 1990s Tony Blair and Bill Clinton developed “the third way”, a pragmatic centre-left doctrine.

Starmer has borrowed heavily from Biden’s emphasis on “family, community and security”, with obvious parallels between Democrat policies aimed at America’s post-industrial “blue wall” and Labour’s attempt to reconnect with its lost “red wall” heartlands in England.

The Labour leader has been briefed by John Anzalone, a pollster for Biden on how the Democrats won back white, male, working class voters. He has also used the phrase “buy, make and sell more in Britain”, echoing Biden’s “buy America” slogan.

David Lammy, shadow foreign secretary, prides himself on his contacts in Washington, while Ed Miliband, shadow climate change secretary, put together his “green prosperity plan” while Biden was drawing up his own package of state intervention, the Inflation Reduction Act.

“Ed has had time with senior pollsters who informed the Biden campaign and have done a lot of work on polling and message testing,” said one Miliband aide. “Our mantra of ‘bills, jobs, security, climate’ is very much inspired by conversations we’ve had with Biden’s people.”

Starmer’s team say they are also drawing heavily from the lessons of recent election victories of Australia’s Labor leader Anthony Albanese and the German centre-left SPD leader Olaf Scholz, both regarded — like Starmer — as solid but relatively uninspiring leaders.

Albanese was in London in May and met senior Labour personnel at the residence of the Australian high commissioner, including Starmer, Lammy, McSweeney and defence spokesman John Healey.

Australia’s Labor party and the British Labour party have recently fought elections that have pitted them against the Australian campaign strategist Sir Lynton Crosby, who has advised right-of-centre parties in both countries.

“The Conservatives and the Australian Liberal party mimic each other because of the Crosby link,” said one senior Labour UK figure, saying that immigration was a common theme in previous elections.

“But Keir also gets on with Scholz as well. The way the SPD ran on a campaign of ‘respect’ echoes a lot of his thinking,” the figure added.

In spite of the increasingly close relationship between Labour and the Democrats in the US, Sunak’s relations with Biden have also warmed over the course of four meetings in the past four months.

The US president endorsed Sunak’s efforts to take a leadership role in regulating artificial intelligence after a 40-minute one-to-one meeting at the White House, which took place without officials, followed by formal talks.

“We are looking to Great Britain to help lead a way through this,” Biden said at a press conference. “There is no country we have greater faith in to help negotiate our way through this.” He added: “We are in lockstep.”