Economy

UK’s high debt poses challenges for new government, warns S&P

S&P Global has issued a stark warning about the UK’s fiscal outlook, highlighting the nation’s high debt levels as a significant weakness for its sovereign debt status.

The ratings agency has indicated that the incoming Labour government will face substantial challenges due to the constrained fiscal environment.

According to S&P, the UK’s debt is projected to peak at 100% of GDP next year, with a slow decline expected in the subsequent years. This fiscal constraint will force Labour to navigate a series of tough policy decisions as it strives to balance economic growth, public service improvements, and fiscal repair.

“The UK’s fiscal position remains constrained and a weakness for our AA sovereign credit ratings,” S&P stated. The agency noted that the general government deficit stood at 6% of GDP in 2023, with gross debt slightly above 100% of GDP, marking the highest level in a decade. This scenario limits the government’s capacity to fund policy initiatives through increased borrowing, especially considering the market’s adverse reaction to previous unfunded fiscal policies, such as those announced by former Prime Minister Liz Truss.

S&P had lifted its negative outlook on the UK’s sovereign debt in April last year, following concerns over public finance stability post the September 2022 mini-budget. The agency downgraded the UK’s AAA rating after the Brexit vote in 2016, maintaining the top rating for only a few countries, including Germany, the Netherlands, Canada, and Australia.

The latest assessment by S&P suggests that an upgrade of UK debt under the new government is unlikely. Despite Labour’s commitment to a self-imposed fiscal rule aimed at reducing the debt pile over five years, S&P remains sceptical about the feasibility of increasing revenues or curbing spending growth. The tax burden is already at a postwar high, and there are persistent pressures to boost public spending due to strained key services, defence funding needs, and the rising costs associated with an aging population.

S&P projects the UK’s budget deficit to narrow from the current 4.5% of GDP this year to 3.2% by 2027. Meanwhile, Chancellor Rachel Reeves is preparing her first budget for the autumn, having tasked Treasury officials with drafting an economic and public finance assessment to be published soon.

Reeves has already announced ambitious plans, including a new housebuilding target of 1.5 million homes by the end of the parliament and a reversal of the ban on onshore wind. Despite the expected election results based on polling, government bond yields have remained stable, with 10-year debt yields trading between 4.1% and 4.2% over the past week.

S&P concluded, “Absent an acceleration in economic growth, stabilising public debt levels will likely be a challenge.”

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