Britain’s debt interest bill risks eclipsing Italy’s

The costs of servicing Britain’s £3tn debt pile will eclipse Italy’s next year if the Iran war keeps driving up prices.

More than a quarter of UK debt is tied to the cost of living, leaving the public finances more exposed to an inflation shock.

Economists warned that debt interest costs could surpass those of the eurozone’s third-largest economy in 2027, if inflation rises above 6.2pc under the Bank of England’s most pessimistic scenario of a drawn-out war.

The Bank warned in April that such a move would require a “forceful” increase in borrowing costs, leading to lower growth and higher unemployment.

While Italy’s debt as a share of GDP is much higher at almost 130pc, compared with around 96pc for the UK, Britain’s share of debt tied to inflation, or index-linked debt as it is known, is roughly two-and-a-half times higher than Italy’s.

Simon French, the chief economist at Panmure Liberum, said surging inflation could push debt interest costs above 4pc of GDP – or roughly £130bn per year – compared with 3.9pc of GDP in Italy.

Mr French added: “The UK has, for good reasons, issued a lot of inflation-linked debt. The principles were sound, investors wanted it and it sent a signal that the government finances would suffer if inflation got out of control.

“The problem is inflation has got out of control, and may do again later in the year under some pessimistic scenarios. This would make it a costly virtue.”

The figures highlight Britain’s vulnerability to higher prices as Donald Trump threatens to take “total control” of Iran’s oil supplies.

Businesses have already warned that food inflation could rise above 10pc by the end of this year amid a surge in fertiliser costs.

Britain’s debt servicing costs jumped to the highest in the G7 as a share of government revenues in 2022, when Russia’s invasion of Ukraine pushed inflation into double digits.

Economists are warning that Britain is headed towards a crisis that could require an intervention by the International Monetary Fund to get debt down.

While inflation has fallen substantially since the onset of the Ukraine war, economists have warned that price rises are unlikely to fall back to the Bank’s 2pc target until the latter half of 2027.

The Treasury first issued index-linked debt in the 1980s after investors shunned gilts because of concerns that Britain wasn’t serious about controlling inflation.

Yields tied to inflation guaranteed investors a real return that was immune to price shocks.

Britain was the first major economy to issue so-called “linkers”, which are now issued by several other major economies, including the US, France and Brazil.

However, the UK’s Debt Management Office (DMO) has cut the amount of index-linked debt it has issued in recent years, amid waning demand from pension funds which used them as a natural hedge against the risk of rising costs.

The UK’s total stock of index-linked debt still stood at £688.5bn at the end of last year, accounting for 25.2pc of the Government’s debt portfolio.

The DMO previously highlighted that if it had continued a previous trend of issuing index-linked gilts, just under half of Britain’s debt could end up being tied to inflation because the value of inflation-linked bonds rises in line with prices.

[Source: Daily Telegraph]