Britain is staring into a £3tn debt abyss

Desk report: “Britain is bust.” Those were not the words of a politician or a scaremongering economist.

They were uttered in 2012 by Sir Robert Chote, then head of the Office for Budget Responsibility (OBR).

He warned that unless the government acted by either spending less or taxing more, the national debt risked spiralling out of control.

At the time, Britain’s national debt had recently surpassed £1tn and alarm bells were already ringing.

Today, the country stands on the brink of another symbolic milestone.

Within months, the United Kingdom’s national debt is expected to exceed £3tn for the first time, a threshold that could be crossed as early as September.

For most people, the moment will probably pass unnoticed. Others will dismiss it as a meaningless figure that says little about Britain’s actual ability to service its debts.

Yet after years of economic crises, rising borrowing, higher spending and repeated failures to reduce the debt burden, the consequences are becoming increasingly difficult to ignore. Changes in market interest rates are blowing up budgets and mere words uttered by politicians can add billions to the nation’s interest bill in a near instant.

Rachel Reeves, the Chancellor, believes she has a plan to get the country’s economy back on the right path. But with Sir Keir Starmer’s Government highly likely to fall in the coming months, there are concerns about what comes next.

Senior economists are raising uncomfortable questions. Chief among them: will the International Monetary Fund (IMF) soon be called back to Britain?

Piling on the pressure

Public debt is currently ticking up at £7,500 per second. That’s an extra £27m every hour or £650m a day as the cost of the financial crisis, lockdown and huge energy subsidies in the wake of Russia’s invasion of Ukraine continue to mount.

It means Britain’s debt pile is on course to hit £3tn by September.

Each of us is on the hook.

When Sir Tony Blair came to power in 1997, it equated to just under £6,000 for every person – adult and child – in the country.

By the time Lord Cameron of Chipping Norton moved into No 10 in 2010, the debt was almost £16,400 per person.

Now our share of the nation’s tab is £42,000 each. By the end of the decade, it will be closing in on £50,000.

The size of public debt matters. But debt as a share of the economy matters even more because it tells you whether the bill is large relative to a country’s ability to pay.

In the coming years, Britain’s debt burden is projected to rise above 96pc of GDP. The last time debt reached that level was in the early 1960s, when the country was still paying down the enormous borrowing accumulated during the Second World War.

At its peak, wartime debt exceeded twice the size of Britain’s annual economic output, a level not seen since the aftermath of the Napoleonic Wars.

However, as David Miles of the OBR points out, there is a crucial difference. Back then, the debt trajectory was moving downwards. Today, it is heading in the opposite direction.

“In the decades after those wars ended, debt did fall, helped greatly by the combination of much reduced military spending and by the return to civilian employment of soldiers,” Miles writes in an academic paper to be published this month.

“Neither of those factors are at play [today].”

Indeed, he argues that the opposite may be true: “It is more likely that military spending will be rising as a share of GDP than falling from its currently relatively low levels.”

As well as increased pressure to spend more on defence, Miles warns that an ageing population will continue to pile pressure on the public finances, with updated projections to be published in July set to show spending on health and welfare will increase substantially in the next 50 years, while public debt heads towards 300pc of GDP.

“In the light of this it would seem … that fiscal policy is on an unsustainable path in the UK,” Miles warns in his paper. “At some point, the stock of debt will have to deviate from that path.”

Decisions, decisions

On paper at least, Britain is making the right choices.

Even though the Government is expected to borrow more than £100bn to balance the books this year – or around 3.6pc of GDP – that number is set to come down quickly towards the end of the decade with some of the fastest belt-tightening in the G7 under Reeves.

“In some ways, the UK Government is doing better than other countries,” says Sir Charlie Bean, a former deputy governor of the Bank of England who was also Miles’s predecessor at the OBR.

“Although you might look at the deficit and say it’s very large and unsustainable, we are actually in the throes of reducing the deficit and quite a lot more tightening is programmed in.”

The UK also has the second-lowest debt ratio in the G7, according to the IMF.

On its slightly different calculations, the national debt of slightly more than 100pc of GDP compares poorly with Germany’s unusually low ratio of below 65pc but looks considerably better than the 118pc in France, 126pc in the US and more than 200pc in Japan.

Yet despite having these factors in its favour, Sir Charlie notes that it still costs the UK much more to borrow than all of these countries.

Why? For one, he says the UK lacks the “captive audience” that the US enjoys because investors just want dollars. The UK also doesn’t have the safety in numbers of countries on the Continent, where the European Central Bank serves as a backstop.

Sir Charlie puts it bluntly: “We look a bit lonely at the moment.”

The OBR has also highlighted that one of the biggest sources of sustained demand for UK gilts is disappearing.

Pension funds no longer need long-term bonds to balance the books like they used to as the defined-benefit schemes that offer a guaranteed income on retirement come to an end.

The OBR warned last year that the cost of servicing Britain’s debt mountain could rise by as much as £22bn per year as workers move from generous final-salary pensions to workplace schemes that largely depend on stock market returns.

Today about 30pc of gilts, as UK bonds are known, are held by foreign investors, while hedge funds now control more than half of the electronically traded gilts market.

That means that not only is the UK increasingly reliant on the kindness of strangers to keep the show on the road, but those investors are also becoming more “fickle and flighty”, with investors now more likely to look for short-term gains than a long-term relationship.

That has made buyers of UK debt at the margin “much more sensitive to price”, says Sir Charlie.

That matters because the UK sells much more debt than it used to. Less than a decade ago, the UK sold around £100bn of bonds every year. This year, it will be closer to £300bn.

Sir Charlie adds that while much of the increase in UK borrowing costs this year has been driven by the Iran war and predictions of fewer interest rate cuts, domestic concerns have not gone away.

Since the conflict began, borrowing costs have risen by more in the UK than in other countries including the US and Germany.

“I would put that down to an element of concern about the direction of fiscal policy in this country if there’s a change in the Labour leadership,” says Sir Charlie.

Andy Burnham, the Labour leadership frontrunner, is causing fear and anxiety in the market as he measures the curtains in Downing Street. However, the current Chancellor hasn’t exactly been the paragon of fiscal rectitude.

Reeves came into office claiming the Tories had left a £22bn black hole in the public finances. She then shocked businesses – and voters – with the scale of her £40bn tax rises in her first Budget.

But what was more remarkable was her spending increases of around £70bn per year, requiring yet more borrowing justified with a new, looser set of borrowing targets.

Unfortunately she left herself with very little headroom to hit those targets.

When the economy repeatedly underperformed, the Chancellor had to ramp up taxes further to get her plans back on track – spooking investors and risking undermining growth once more.

The result is rising borrowing costs amid growing fears in financial markets that Labour is struggling to keep a lid on debt. The expectation of yet more spending if Burnham becomes prime minister only adds to the upward pressure on market interest rates.