Beware the siren song of cheap debt
The aftermath of the UK’s decision to leave the European Union has been an uneasy calm. Inflation is at a 20 month high of 0.6%, unemployment is at a post-crisis low, and consumer spending is robust. But then of course, nothing has happened yet.
Forecasts for the coming years remain obstinately grim, and with good reason. The currency has not recovered and GDP growth, though improving, remains sluggish.
The issues of bank passporting, single market access and free movement will take time to resolve. As each negotiation progresses, speculation on the outcome will abound and the resultant turbulence could damage economic confidence.
However, despite the turmoil, the UK DMO is likely to continue to have access to extremely cheap debt.
In the short term, low borrowing costs allow breathing room for refinancing and could help fund attempts at coaxing the economy into growth.
In the long term though, the rating agencies have made it clear that the UK must rein in its debt to GDP ratio, curtailing spending and raising revenues. Failure to do so will result in further downgrades.
But when will the reins be pulled? Yanking away the crutch of loose fiscal policy will be painful for any politician to administer.
The possible downgrades may have no effect on the UK’s cost of funds. After all, economic uncertainty in the UK will pull borrowers towards the relative security of Gilts. The downgrade in the wake of the vote for Brexit barely mussed the DMO’s hair.
But even if downgrades do not raise the DMO’s borrowing costs, they should still serve as a warning. Even cheap debt can become unsustainable.