Sunak worries about risk of rising interest rates

A rise in global interest rates that could destabilise the UK’s public finances is one of the risks that keeps him up at night, chancellor Rishi Sunak told MPs on Thursday.

Giving evidence to the House of Commons Treasury committee on the Budget he outlined last week, Sunak said it was too soon to tell how much long term damage the economy would sustain from the coronavirus pandemic.

But the other big threat to the UK’s fiscal outlook was the risk that a long-term decline in interest rates — which has allowed governments to ramp up borrowing at much lower cost than in the past — might go into reverse.

“The public finances are much more sensitive to changes in interest rates and inflation than they were previously,” Sunak told MPs.

“Interest rates are and have been exceptionally low — still, they could rise . . . to what would still be historically very low levels, and that would have a significant impact . . . on the public finances over the next few years.”

Even with the higher rate, if you look at the shop window as a whole, there are lots of goodies that will make sure this is a really attractive place to come and do business.

Over the past month, investors have increasingly expected higher inflation and interest rates because of a vaccine-fuelled improvement in the economic outlook.

The European Central Bank on Thursday said it would step up the pace of its bond-buying programme, partly in response to an increase in yields that officials fear could act as a headwind to the eurozone’s economic recovery.

The Office for Budget Responsibility last week flagged up the risks that rising bond yields posed to the UK’s public finances.

The fiscal watchdog said the increase in yields on 10 year benchmark gilts since it had closed its forecasts for the March 3 Budget would — taken in isolation — threaten Sunak’s goal of stabilising government debt levels.

Sunak acknowledged these risks had been amplified by the recent expansion of quantitative easing by the Bank of England, and said his goal would be to insulate the public finances by the government issuing debt with longer maturities.

Separately, the chancellor sought to answer criticism that the Budget’s projections for government spending were unrealistic, because they implied cuts to previous plans at a time when many areas of public services face intense pressures.

He said spending would still grow in real terms over the course of the parliament, and the size of the state would be “quite chunky by historic standards” as a percentage of gross domestic product by 2025.

Sunak also defended the government’s proposed 1 per cent pay rise for nurses — strongly criticised by trade unions and Labour — saying it was “based on affordability”.

But he came under fire from MPs for failing to prevent wasteful spending by the government on contracts for personal protective equipment as well as the ramp up of the test and trace programme.

Sunak said that at the start of the pandemic it had been right to show “flexibility” in the way contracting for PPE had been done and to put “an enormous amount of investment” into expanding testing capacity. But he added: “If there are lessons to be learned, of course we will learn them.”

Meanwhile Sunak denied his proposed increase in the UK corporation tax rate from 19 per cent to 25 per cent in 2023 would seriously damage Britain’s attractiveness as a location for inward investment.

“Even with the higher rate, if you look at the shop window as a whole, there are lots of goodies that will make sure this is a really attractive place to come and do business,” he told MPs, saying the UK had an attractive offer to business in terms of research and development tax credits, skills and infrastructure.

Sunak said business welcomed the “certainty” of knowing in advance that corporation tax would rise later in the parliament, but would also benefit from the temporary “super-deduction” scheme to allow companies to cut their tax bills when they invest.

The chancellor defended the government’s plan to cut the UK’s overseas aid budget by £4bn: it will fall from 0.7 per cent to 0.5 per cent of GDP.

MPs are demanding a vote on legislation to confirm the abandonment of the 0.7 per cent target.

Sunak did not guarantee such a vote, but said: “Of course we would not want to be breaking the law.”