This Forecast in-depth page has been updated with information available at the time of the October 2024 Economic and fiscal outlook.
The Treasury manages public spending within two ‘control totals’ of about equal size:
departmental expenditure limits (DELs) – mostly covering spending on public services, grants and administration (collectively termed ‘resource’ spending) and investment (‘capital’ spending). These are items that can be planned over extended periods.
annually managed expenditure (AME) – categories of spending less amenable to multi-year planning, such as social security spending and debt interest.
Debt interest spending is one of the largest items in AME. Most public sector debt interest spending is accounted for by central government and payments relating to funded pension schemes in the public corporations sector. For central government, the biggest components are interest paid on government bonds (known as ‘gilts’, of which there are two types: conventional gilts that pay a fixed amount of interest and index-linked gilts that pay an interest rate linked to RPI inflation), payments to holders of NS&I savings products and on the reserves (in effect electronic money) created by the Bank of England for monetary policy purposes. The Bank holds lots of gilts (mostly in the Asset Purchase Facility (APF)) and is part of the public sector, so the interest paid by central government on those gilts does not actually leave the public sector. Payments relating to funded pension schemes represent additional accrued spending because retirement is one year closer (known as unwinding of the discount rate). As we outlined in our explainer on the direct fiscal consequences of unconventional monetary policy, the net effect on public sector debt interest of the APF holding gilts is the difference between the coupon interest earned on the gilts and the interest paid on the reserves created to finance the purchase of the gilts.
As shown below, in 2024-25 we expect debt interest spending to total £104.9 billion. That would represent 8.2 per cent of total public spending and is equivalent to over 3.7 per cent of national income.
The charts above show debt interest spending in nominal terms (i.e. the current money value without taking inflation or other factors into account) and as a share of national income (GDP). Spending measured in nominal terms is a simple metric for analysing trends over time. But without putting this amount into context – by asking how much national income is devoted to different types of public spending – interpreting changes in spending is difficult, particularly over long time periods.
Trends in spending as a share of GDP are useful to understand how spending moves in line with the underlying economic activity that ultimately finances it via taxation. In nominal terms, both spending and GDP will tend to rise over time because of population growth and inflation. Spending as a share of GDP is the most relevant metric when considering the sustainability of the public finances.
Despite the large increase in the amount of debt since the financial crisis of the late 2000s, debt interest payments fell by 0.8 per cent of GDP over the nine years to 2019-20. The principal drivers of this were the increase in the amounts of gilts held in the APF (in effect substituting low-interest bearing Bank of England reserves for gilts), generally low RPI inflation (reducing the accrued cost of servicing index-linked gilts) and historically low interest rates, which repeatedly fell below market expectations. The pandemic resulted in a further 0.5 per cent fall in debt interest payments as a share of GDP between 2019-20 and 2020-21. This reflects the combined effects of lower inflation, interest rates and a further expansion of asset purchases through the APF, outweighing the impact of significantly greater debt issuance. Debt interest spending reached a post-war high of £111.6 billion in 2022-23, or 4.4 per of GDP, as inflation reached a 40-year high and interest rates surged. While debt interest spending has since fallen from this record, it is forecast to remain at historically elevated levels over the next five years.
The Treasury coordinates the production of our debt interest forecast based on our assumptions about interest rates and forecast for RPI inflation. We discuss these forecasts at challenge meetings where we scrutinise the latest data and the effects of our assumptions and judgements.
The mechanics of the debt interest forecast are somewhat different to other AME forecasts because of the interactions between the central government net cash requirement (CGNCR) – which we derive from our full fiscal forecast – and our central government gross debt interest forecast. This means that we need to iterate the forecast until the CGNCR and the debt interest forecast converge on their final values. This is known as the ‘debt interest loop’ and is run in the OBR at the very end of our fiscal forecast process. The following diagram summarises this process:
Forecasting model
Debt interest payments are forecast by applying interest rates to the stocks of different liabilities.
Our debt interest forecast process starts with estimates of the stock of different types of debt on which government must pay some form of debt interest. These include:
conventional gilts;
index-linked gilts;
the assets and liabilities of the APF; and
other financing products (such as Treasury bills and NS&I products).
The largest component of debt interest is the interest paid on conventional gilts. For the existing stock of conventional gilts, payments are known and fixed. By contrast, estimates for interest payments on existing index-linked gilts and for all new debt issuance can be subject to larger revisions due to changes in our economic and fiscal forecasts (including changes in RPI inflation, interest rates and the net cash requirement – a measure of the deficit).
We forecast changes to the various stocks of debt by considering the gilts and other liabilities that will become due to be redeemed, and the additional debt issuance that will be required to cover the net cash requirement for each year, plus the redemptions of the existing stock.
We then have to make assumptions about the composition of gross financing each year to cover the cash deficit and redemptions, and the interest rates that will apply to the new debt issuance. These interest rates are derived from financial market expectations and our RPI inflation forecast (for index-linked gilts).
The debt interest forecast is expressed as net of the effect of gilts held by the APF. The APF receives coupon income on the gilts it holds, while the Bank of England pays Bank Rate on the reserves it created to finance the asset purchases made by the APF. The coupon payments cancel out within the public sector, so this debt is in effect financed at Bank Rate. The Bank started active sales of gilts on 1 November 2022 and the Monetary Policy Committee (MPC) states its sales intention annually on an October to September basis. It has indicated that it will reduce the stock of gilts held in the APF by £100 billion in the year to September 2025. Thereafter our APF runoff assumption reflects the Bank of England’s public statements on how it intends to unwind the APF. More detail on our current assumption is in paragraph 6.12 of our October 2024 Economic and fiscal outlook.
Our central government debt interest forecast includes interest payments made by Network Rail, which are classified as part of central government by the ONS, as well as other smaller payments, such as interest on finance leases.
Forecasts for debt interest spending by local authorities and public corporations, including the non-APF parts of the Bank of England, are produced in a similar way by applying appropriate interest rates to projected stocks of debt liabilities.
Main forecast determinants
The main economic determinants driving our debt interest forecast are those related to:
Our forecast for the Retail Prices Index that determines the accrued debt interest payments on index-linked gilts.
Our market-derived assumptions for conventional and index-linked gilts rates that are used to forecast debt interest payments on conventional and index-linked gilts. We use an average conventional gilt rate obtained combining the yield on a short, a medium and a long-term government bond with the proportions of each in total issuance consistent with recent outturns and government debt management policy. Our real index-linked gilt rate is from a long-dated index linked gilt.
Market expectations for Bank Rate that are used to forecast the debt interest payments on the APF’s loan.
Our market-derived assumption for short-term market interest rates that is used to project forward payments on Treasury bills and other short-term debt instruments. This is typically very close to Bank Rate.
The forecast is also driven by the central government net cash requirement (CGNCR) that determines the net amount of new debt that must be issued, on which additional interest payments must be paid. This is added to the new debt issuance associated with the known amounts of gilts that are due to be redeemed to get to gross debt issuance. For more detail on the sensitivity of our debt interest forecast to changes in these determinants see ‘detailed forecast tables: debt interest ready reckoner’, published alongside our October 2024 Economic and fiscal outlook.
Main forecast judgements
Much of our debt interest forecast reflects the consequences of judgements we make about other parts of the forecast – about inflation, what source to use for interest rate assumptions, and the overall fiscal forecast that drives the cash requirement. The most important judgments in our debt interest forecast are:
the proportions of different types of gilts that will be issued and whether this is skewed towards shorter or longer-term debt, index-linked gilts and so on; and
the size and composition of the gilts and other assets held in the APF and the size and timing of active sales across the forecast.
As mentioned above, higher inflation and interest rates mean our latest forecast for debt interest is far higher than previous ones in the short term. However, debt interest payments have generally been significantly lower than expected across our previous forecasts, much of which can be explained by assumptions about the key underlying determinants. Interest rates – both short-term rates and longer-term gilt rates – have been lower than market expectations (on which we base our assumptions) at the time of almost every previous forecast. Lower RPI inflation over the recent past has also contributed to the errors by reducing the effective rate on index-linked gilts. We have also changed our assumptions on the behaviour of the APF over time as Bank of England’s guidance about how the APF will be operated has evolved.
Other changes to our forecasts include:
The composition of gilts issued, which was initially more skewed towards relatively cheaper short-term debt and index-linked gilts than we had assumed in some earlier forecasts, leading to lower spending. (However, since March 2018, the Government has begun to reduce the proportion of index-linked gilts in its financing plans.)
Revising our assumption that the split of issuance would converge towards historical patterns to one where we now assume that it remains in line with the latest year’s financing remit.
A correction to the way we predicted the stock of debt, which related to modelling the refinancing of gilts at redemption and had caused us to over-estimate the stock. We corrected this in our December 2014 forecast.
The ONS treatment of the APF was changed between our forecasts in March and December 2014, which means our earlier forecasts are not directly comparable with those since the change. Originally its effects were excluded completely, in line with the approach at the time of excluding the effects of things judged to be related to the financial crisis. It is now included, because only the effects of the public sector banks (e.g. the Royal Bank of Scotland) are excluded from the headline public sector finances statistics.
‘Ready reckoners’ show how our fiscal forecasts could be affected by changes in selected economic determinants. They are stylised quantifications that reflect the typical impact of changes in economic variables on receipts and spending. These estimates are specific to our March 2024 forecast and we would expect them to become outdated over time as the economy, public finances and policy environment continue to evolve. They are subject to uncertainty because they are based on models that draw on historical relationships or simulations of policy settings. More information can be found in the ‘ready reckoners’ spreadsheet available on our Data page.
The table below shows the effect at the forecast horizon of the following shocks that are assumed to take effect at the beginning of the first year of the forecast and continue until the final year:
a 1 percentage point increase in gilt rates in 2024-25 (which persists in each subsequent year of the forecast) increases debt interest payments by rising amounts over the forecast period, reaching £12.0 billion by the end of the forecast. This increases steadily over time as the rate increase only affects new gilt issuance;
a 1 percentage point increase in short-term interest rates in each year of our forecast has a large impact in 2024-25 and 2025-26 which declines slowly thereafter. Unlike the gilt rate effect, short-rate changes are almost instant and affect the entire stock of relevant debt, which decreases in our forecast due to the unwinding of the APF;
a 1 percentage point increase in RPI inflation in 2024-25 increases debt interest payments by £5.9 billion in the same year and by rising amounts over the forecast period; and
a £10 billion increase in the central government net cash requirement in 2024-25 has a comparatively small impact on the forecast, pushing debt interest spending up by £2.3 billion by the final year.
Debt interest: ready reckoners
£ billion
2024-25
2025-26
2026-27
2027-28
2028-29
1 percentage point increase in gilt rates
1.3
3.7
5.8
7.6
9.6
1 percentage point increase in short rates
8.1
7.6
6.8
5.7
4.9
1 percentage point increase in inflation
6.5
7.5
8.1
9.1
9.9
£10bn increase in CGNCR
0.2
0.6
1.0
1.4
1.8
Note: All increases are assumed to take effect at the beginning of 2024-25 and continue throughout the forecast.
