Interest charges to remain excessive as Chancellor ramps up public sector pay

‘Black hole’: Chancellor Rachel Reeves

Rachel Reeves is expected to sign off a series of inflation-busting public sector pay deals that could cause the Bank of England to keep interest rates at a 16-year high this week.

The Chancellor is expected to lay the ground for tax rises in her Autumn Budget when she reveals the outcome of a Treasury audit into the Government’s finances tomorrow. 

This is expected to show a £20 billion-a-year ‘black hole’ in the public accounts, which Reeves will try to pin on the ‘shocking inheritance’ left by the previous Tory government.

But experts say half of the shortfall is due to the cost of funding higher than expected pay awards for millions of NHS workers, teachers and other public sector staff that Reeves herself is expected to sign off.

Independent reviewers have recommended rises of 5.5 per cent for nurses and school staff – well above the 3 per cent pencilled in by the Treasury.

The Institute for Fiscal Studies think-tank reckons if this kind of rise was extended to the rest of the public sector the bill would be an extra £10 billion a year.

That figure includes the cost of generous taxpayer-funded pension contributions, which in the case of civil servants is 29 per cent of salaries. These pay awards alone would wipe out the thin £8.9 billion of ‘headroom’ against the Government’s borrowing rules left by Conservative Chancellor Jeremy Hunt in his March Budget.

Reeves’ announcement to Parliament tomorrow comes days before the Bank’s rate-setting Monetary Policy Committee meets.

It has kept the cost of borrowing at 5.25 per cent to tame inflation, though price rises have slowed to the Bank’s 2 per cent target.

The committee is watching the public sector pay round closely amid concerns that high earnings growth could tip the economy into an inflationary wage-price spiral, where high wage growth fuels price rises, which feeds back into higher wage demands, and so on.

Wage growth in the private sector slowed to 5.6 per cent in May – in line with the Bank’s forecasts – but a higher-than-expected public sector pay deal may delay interest rate cuts.

Traders expect the Bank to cut rates in September but Swiss bank UBS thinks a rate cut could come as soon as Thursday.

New MPC member Lombardelli is ‘wild card’

The committee split 7-2 in favour of keeping the cost of borrowing on hold last month, it notes. 

Both Governor Andrew Bailey and a deputy, Sarah Breeden, are seen as swing voters, having judged the latest decision to hold rates as ‘finely balanced’.

The wild card is the former Treasury official Clare Lombardelli, who joined as deputy governor last month. Anna Titareva, an economist at UBS said: ‘Little is known on her voting intentions.’

Mortgage rates are already falling in anticipation of rate cuts.

Last week, Nationwide offered a five-year home loan fixed at less than 4 per cent – the first lender to do so since April.

Reeves has so far refused to say how she will plug the hole in the public finances. She has ruled out rises in the biggest revenue-raisers – such as income tax – but experts say she could swoop on capital gains and inheritance taxes instead.

Another option is to target tax relief on pension contributions. Basic rate taxpayers pay 80p for every £1 put into a private pension pot, whereas those paying 45 per cent income tax chip in just 55p, with the State making up the difference.

Flat rate tax relief of 30 per cent would raise £2.7 billion extra a year, the IFS says.

A Government spokesman said: ‘We value the vital contribution nearly six million public sector workers make to the country.’