How deep is the UK’s fiscal hole?

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A week is a long time in politics, as Angela Rayner can attest, but it’s a lifetime in the gilt market. The 30-year gilt started the week with a yield of 5.61 per cent. By Wednesday morning, the yield had hit 5.75 per cent. At pixel time, it’s trading with a yield of 5.51 per cent.

Gilt yields are important. They are a baseline for the interest rates that private sector agents will have to pay on new sterling borrowing. They also feed into the national fiscal arithmetic.

As MainFT’s explainer explained at the weekend, higher gilt yields may reflect an expectation for higher interest rates in a world of sticky inflation. They may reflect expectations for a projected mismatch of supply and demand — given defined-benefit pension fund buyers are anticipated to pretty much disappear, and long-dated gilt supply is still substantial.

But ever since The Sunday Telegraph and the Daily Mail ran big pieces with near-identical headlines along the lines that Britain is heading towards IMF bailout, social media — and some more sensationalist titles — have been awash with the idea that the UK is on the brink of default.

How much worse are UK government finances than G7 peers? We grabbed a couple of charts from the IMF comparing the UK to the rest of the G7.

Government deficits:

Gross government debt:

The numbers are not great. But the IMF projection for the UK’s fiscal pathway looks better than most.

We’ve argued before that it’s actually debt service costs — that is to say, the proportion of GDP needed to be put aside to pay interest payments that have been promised to bondholders — that really can’t be ignored by finance ministries. Over time, you’d expect these to move towards the product of debt/GDP and average interest cost.

The next chart shows where the IMF reckons this is across the G7, and we’ve drawn lines showing where it will move over time if yields hit certain levels:

Because much of global government debt was issued at lower interest rates and doesn’t need refinancing tomorrow, interest service costs will rise pretty much everywhere — eating into other spending commitments, or prompting tax rises — but rise slowly. So finance ministries certainly can’t ignore market interest rates.

Why then has investor confidence collapsed in the gilt market compared to government bond markets of the rest of the G7?

It’s not clear that it has. Gilt yields have swelled and dipped this year much like they have in other core government bond markets:

No doubt, gilt yields are uncomfortably high for the chancellor ahead of the November budget. In order to meet her self-imposed fiscal rules, these elevated yields point to some combination of higher taxes or lower spending. And it’s not clear how she will get herself out of the corner she has painted herself into.

But the idea that UK finances are either uniquely troubled, or that the gilt market has been singled out by bond vigilantes reckoning that the country is on the brink of an IMF bailout, just doesn’t hold up.

As Neil Shearing, group chief economist at Capital Economics, wrote in a note to clients:

The IMF is not called into countries that can finance themselves in their own currency and retain the confidence of investors. It is usually summoned when chronic fiscal and balance of payments deficits have built up unserviceable foreign currency liabilities, or when banking systems buckle under the weight of external debt. Britain, for all its shortcomings, is not in this category.