The UK faces unfunded spending pressures as a result of the pandemic that could require higher taxes or more borrowing, the country’s fiscal watchdog said on Tuesday.
The Office for Budget Responsibility said funding shortfalls in health, education and transport could cost £10bn a year until 2025 to fill. It said these were just some of the “legacy costs” of the pandemic are a risk to the public spending outlook.
In its risk report, the OBR also looked at the potential impact of higher interests on the government’s £2tn debt, which soared as the Treasury spent to support the economy during the crisis. The impact has been cushioned by ultra-low interest rates meaning the UK only pays 0.9% to service its debt.
If rising interest rates are matched by productivity growth the outcome is relatively benign but in a gloomier scenario the interest rate on government debt increases, pushing borrowing to almost 7% of GDP by the middle of the century.
The watchdog also also considered the “extreme case” where investors lose confidence in the UK’s credit worthiness, leading to a flight from government bonds.
“This leads to a vicious circle where rising debt raises borrowing costs, which in turn increase the rate at which debt rises,” the OBR said. “In this scenario, an adverse shock, similar in magnitude to that experienced in the financial crisis, and a loss of investor confidence lead to a sterling depreciation and a rise in the risk premium on gilts.”
This leads to interest costs reaching a record 9.5% of GDP in 2029-30.
The OBR said nations’ fiscal plans were increasingly exposed to catastrophic risks, highlighted by the financial crisis and the pandemic happening in quick succession.
“While the threat of armed conflict between states (especially nuclear powers) appears to have diminished in this century, the past 20 years have seen an increase in the frequency, severity, and cost of other major risk events, from extreme weather events to infectious disease outbreaks to cyberattacks,” the OBR said.
Achieving net zero emissions by 2050 will require £42bn a year of investment to decarbonise power generation, household and commercial heating and manufacturing, the OBR said. Delaying investment until the start of the next decade will cost twice as much as starting now, it added.