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UK public finances vulnerable to higher inflation, says Sunak

Rishi Sunak warned that the UK economy and public finances were “vulnerable” to higher inflation and interest rates in comments ahead of the spring statement suggesting that tough decisions could be required in the months ahead.

Responding to a Treasury Committee report into last year’s Budget, the chancellor said the government “can absorb some shocks and adjust fiscal policy as needed”.

But with the deficit lower than expected so far this financial year, Sunak is not expected to make big changes to taxation or public spending in his spring statement on March 23.

In its report, the committee expressed concern that the government had contributed to the UK’s high rate of inflation, which hit 5.5 per cent in January and is expected to top 7 per cent by April. It said Sunak’s decision to increase National Insurance to bolster the health and social care sector had contributed to these inflationary pressures by fuelling high pay claims and encouraging companies to protect margins by raising prices.

The chancellor ignored these criticisms in a response published on Wednesday, but expressed concern about the effect of higher inflation on the cost of servicing UK government debt.

“The UK’s high level of debt means we are vulnerable to changes in macroeconomic conditions such as interest rates and inflation, which would increase the amount we spend on debt interest rather than public services,” Sunak wrote.

He hinted that he did not need to raise taxes again so soon after his tax-raising Budget in October.

“Rolling fiscal rules means we can absorb some shocks and adjust fiscal policy as needed, but the government has already made tough decisions which demonstrate our commitment to keep debt under control, such as delivering a long-term, sustainable funding solution for the NHS and reform of the adult social care system”.

The forecasts from the Office for Budget Responsibility, the fiscal watchdog, are likely to show improved public finances in the short term and a less certain outlook in subsequent years, with the higher costs of servicing debt balanced by the positive effects of wage inflation on taxes on incomes.

In the first 10 months of the 2021-22 financial year, the level of borrowing was £17.7bn lower than the OBR’s estimate for the same period even thought it was still running at a high level.

The fiscal watchdog said in October that a rise in inflation is generally bad for the public finances in the short term if it arises from higher costs, such as recent rises in energy prices, but this is mitigated in the medium term by higher wages.

However, the OBR said the more inflation is driven by a tight labour market and pay gains, the more it improves the short term public finances, although it also increases pressure to bolster public spending.

Mel Stride, who chairs the Treasury Committee, welcomed Sunak’s acknowledgment of the potential threats from rising prices saying the chancellor was “completely alive to the very real risks of rising inflation”.

“With financial sanctions rightly being imposed on Russia, the cost of gas is likely to continue to increase, leading to higher inflationary pressures,” Stride added.

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