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A rise in inflation, temporary, or persistent, following the Covid shock will not improve the UK public finances due to the relatively large proportion of outstanding UK debt in inflation linked gilts, along with the distorting effects of quantitative easing which has swollen interest bearing central bank reserves, the Office for Budget Responsibility stated in its Fiscal risks report published Tuesday.
The OBR's report worked through scenarios with a temporary rise in inflation and one where inflation persists at 4%. In the latter scenario public sector net borrowing rises because of higher net interest costs resulting from a mix of increased linker payments, higher payouts on central bank reserves and higher average gilt rates, which combined outweigh the decline in the lower primary deficit. The OBR, the official UK fiscal forecaster, pushes back hard in the report against what it sees as the outdated view that high debt can simply be inflated away and its persistent high inflation scenario net interest costs rise to 4.4 per cent of GDP by 2050-51 compared to 1.0% in its baseline.