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LONDON – The British government would fail spectacularly if its finances were subjected to the same sort of stress tests carried out by the Bank of England on the UK’s lenders, a scathing report from the independent Office for Budgetary Responsibility released on Thursday shows.
Every year, the Bank of England tests how resilient banks would be in the event of a global economic catastrophe.
The process, known as stress testing, sees how much the UK’s biggest banks would lose under different scenarios, and whether they have enough capital to survive those losses.
The OBR – which is tasked with scrutinising the Treasury – ran the government’s finances through a similar test to see how they would stand up, mimicking the Bank of England’s parameters. The results are troubling, to say the least.
The OBR’s scenario included “a deep recession, with asset prices and the pound falling sharply and lasting effects on potential output,” as well as rocketing domestic inflation, which in the hypothetical scenario forces the Bank of England to raise interest rates.
“The Government’s fiscal targets would be missed by wide margins,” the OBR notes in the report, saying that the deficit could balloon to 8.1% of GDP in the next five years, with the UK’s overall debt burden growing to around 114% of GDP, up from around 90% now.
Weak wage growth, rising inflation, and likely rising interest rates, as well as the threat of a recession, mean that the UK’s public finances are on a worrying trajectory.
“Higher spending – especially on debt interest – accounts for more of the deterioration in the stress test than it did in the crisis and the loss of income tax receipts accounts for less,” the OBR says.
“The stress test highlights areas where sensitivity to risks has increased,” the report notes. “In particular, debt interest spending is more sensitive to changes in interest rates and inflation, because there is more debt and more of it is either short maturity or linked to the Retail Prices Index (RPI).
“Relative to the eve of the crisis, debt interest spending as a share of GDP is now four times more sensitive to interest rate changes and two-and-a-half times more sensitive to movements in RPI inflation.”
Here is the OBR’s set of charts, with the red lines illustrating the stress test scenario:
Brexit could make things even worse – the report suggests that the economic impact of UK leaving the EU could cause the government’s debts to surge even more over the long term. “If GDP and receipts grew just 0.1 percentage points more slowly than projected over the next 50 years, but spending growth was unchanged, the debt-to-GDP would end up around 50 percentage points higher.”