Today’s near zero borrowing costs saved the UK by lowering the cost of servicing our debts, but interest rates now look set to soar as inflation takes off. A financial expert warns that Sunak sleeps on a “bed of nitroglycerin” and that taxpayers will have to foot the bill if he explodes.
The Bank of England predicts inflation will hit 4% this year, but could climb to 6-7% as prices skyrocket amid record energy costs and supply shortages.
This would force the Bank’s Monetary Policy Committee to raise policy rates to prevent the economy from overheating, and the backlash could be severe.
Higher interest rates would increase the cost of servicing the UK’s mind-boggling debts and wipe out much of the additional income Sunak expects to generate from its controversial move to freeze income tax, rights to inheritance and capital gains tax breaks through 2026, in its March Budget.
This could force him to raise the three taxes again to raise even more funds.
In 2010, bond guru Bill Gross warned that the UK gilt market was sitting on a “bed of nitroglycerin” due to the country’s scale of debt.
It hasn’t exploded yet, but that could be about to change.
AJ Bell’s investment analyst Laith Khalaf said Bill Gross was right to be concerned, but made his prediction too soon. Now UK debt could finally explode under Sunak’s watch.
“Bill Gross made his prediction a decade earlier, but the risk is growing and the impact could be even greater today.”
The Bank of England has pegged Â£ 875 billion of debt to the base rate, rather than locking in to long-term fixed rates in the gilt market, Khalaf warned: âThe base rate is a rate. floating interest rate that can change overnight.
The Office for Budget Responsibility said in March that if UK interest rates were to rise by just 1%, it would add a staggering Â£ 20 billion to the average cost of servicing the country’s debt.
That’s Â£ 20 billion that Sunak needs to find EVERY YEAR.
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Khalaf said it’s a lot more money Sunak will raise thanks to the tax increase in his March budget.
“This would wipe out all of the Â£ 8.2bn gains the Treasury expects from the freeze on income tax cuts until 2026, as well as a significant portion of the Â£ 17.2bn increase sterling corporation tax “.
If rates rise by 2%, the annual bill could double to Â£ 40bn, which force Sunak to raise even more money from desperate taxpayers.
Over the past two months, Gilts yields have doubled from 0.5% to a two-year high of around 1.10% as inflation fears grow. The higher they climb, the greater the danger.
Any investor holding bonds is in grave danger, Khalaf said. “Bonds are a traditional safe haven, but it can give investors a false sense of security.”
Khalaf said 12 years of ultra-accommodative monetary policy pushed gilts prices so high that the crash could be brutal. “Some UK bond funds have suffered double-digit declines so far this year.”
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Khalaf said that even if inflation were to fall, it would simply be a stay of execution. “Unless we think monetary policy will never normalize and interest rates will stay low forever, there has to come a judgment day for the bond market.”
He issued this chilling warning: âIt’s a question of when, not if. “
When that happens, taxpayers could also face a day of settlement as UK debt could ignite.
Jason Hollands, managing director of Tilney, said that in uncertain times, investors are flocking to the perceived safety of government bonds.
âIt would be a very dangerous decision today. Bond yields are negative in real terms if you factor in inflation, but prices are high. “
Fawad Razaqzada, market analyst at Think Markets, warned that central bankers are powerless in the face of âstagflation,â where the economy stagnates while prices rise. “Further monetary easing will only further exacerbate inflation.”