MNI INTERVIEW: Rate Path Key To UK Fiscal Headroom - OBR Miles

The fall in UK government debt yields in the short time since the Office for Budget Responsibility prepared forecasts accompanying this week’s Autumn Statement has roughly doubled the amount of headroom for the government to meet its goal of getting debt-to-GDP declining five years ahead, David Miles, a member of the OBR's three person Budget Responsibility Committee, told MNI.

The OBR’s forecasts, based on data from the 10 working days to Nov 4, showed only GBP9 billion in headroom compared to the government’s fiscal goal, but gilt yields have fallen markedly since, and with debt approaching 100% of GDP, the difference is substantial, said Miles.

“Nine billion of headroom relative to the risks that could play out over five years is very, very small. If our central forecast was based on the past few days of gilt yields, just updating the interest rates, you could double the headroom from nine to almost twenty billion," Miles said.

BOE RATES

The OBR based its economic and fiscal forecasts on the market rate path and showed inflation peaking around 11% before sinking below the 2% target to trough at just below zero. While it is easy to argue this suggests markets have been overdoing likely tightening and that the Bank of England will have to cut aggressively down the road, Miles, formerly a two-term member of the Bank’s Monetary Policy Committee, believes the MPC will look through both inflation overshoots and undershoots.

MPC members are “willing to live with a substantial overshoot of inflation and not aim to bring it down in just a few months because they think it is, to a significant extent, transitory," Miles said.

The MPC would similarly look through the anticipated reversal of the steep rise in energy prices which has driven the recent spike in inflation.

"You can argue that this might happen on the flipside. If inflation, for a few quarters, falls down to near zero in the wake of energy price falls - but was expected to move back to target - it is not so clear that slashing interest rates is the likely response,” Miles said.

Market rate curves, which have been very volatile, are now indicating growing chances of a switch to monetary easing, after having recently shown Bank Rate peaking at over 5%.

"It is not so obvious that the current market curve, even if you believe our forecast that inflation drops to zero and then goes slightly negative, is quite so implausible," Miles said.

“The MPC likely will raise interest rates a bit further … but they are certainly not raising interest rates consistent with them believing you have to get inflation close to target in a few months, because they too think inflation will fall back sharply further ahead." (See MNI POLICY: BOE Points To 4% Peak At Most, Then Rate Cuts)

DEFINING PUBLIC SECTOR DEBT

The government decided not to alter its definition of public debt to include the BOE’s net assets and liabilities, even though this would have made it easier to project a future fall in the debt-to-GDP ratio as banks replay Term Funding Scheme loans.

Miles said this was the correct decision.

"It doesn't make much sense then to artificially inflate the stock of net government debt and then have it fall like a stone a couple of years in the future as if, somehow, the government has now got debt falling fast," he said.

"The Bank of England lent a load of money against a large amount of collateral which, with an extraordinarily high probability, is going to be repaid, not in 20, or 30, or 40 years but in a few years," Miles said.