This graph uses November 208 pre-Budget report projections, however, even these are likely to be too optimistic.
It is the sharp deterioration in government finances that have concerned the markets.
Last week, the government faced the embarrassment of a failed gilts auction.
Government debt is financed by selling government bonds (or gilts). The Bank of England used to sell gilts but it is now done by a new body - The UK Debt Management Office (DMO)
The UK Debt Management Office (DMO) attracted just £1.67bn in bids for its sale of £1.75bn of 2049 gilts this morning, its first uncovered auction of conventional gilts since 1995.
The cover of just 0.93 times is one of the lowest on records.
Impact of a Failed Gilts Auction:
- Will put upward pressure on gilt yields. To attract more people to buy gilts, the government will have to offer a higher interest rate to encourage people to buy. This increases the long term cost government borrowing. Higher rates can also be deflationary and reduce economic growth (Higher interest rates from government borrowing are called financial crowding out)
- Limits future discretionary fiscal policy. The record rise in government borrowing is primarily because of automatic stabilisers. - In a recession tax receipts automatically fall because people pay less income tax and less corporation tax. The government is also spending more on unemployment benefits. However, as Mervyn King pointed out last week, the state of government finances means that future tax cuts and spending increases may be unsustainable.
- Impact on Credit Rating. Currently the UK has a triple A credit rating. However, any more failed gilt auctions would likely reduce our credit rating making it more difficult and expensive to finance future borrowing.