Work longer, and expect higher interest rates

October 6, 2009

It’s bad luck if you’re a 59-year-old British male, planning to retire at 65 in 2016 – you may have to wait another year to collect your pension. Your wife is already reconciled to watching her retirement age drifting further into the future, so that each year she works brings it only six months nearer.

The UK state pension is stunningly expensive. Even the modest move announced by the Conservatives at their conference on Tuesday will save 13 billion pounds a year, or half the revenue from fuel duty. As longevity increases, the state pension age must be raised much further, but this proposal is the first instalment of what until now has looked more like theoretical economics than the prospect of personal financial pain.

There is much more to come. It’s not even possible to predict next year’s gap between government spending and revenue to within 13 billion pounds. Next month’s Pre-Budget Report will be another horror show, like the April Budget which forecast a shortfall of 175 billion pounds. Effectively, everything spent this year on health, transport and defence has been borrowed from the Bank of England, that modern equivalent of printing money to pay the bills. 

Printing money seems to be cost-free, but only as long as the markets believe in the nation’s credit. If there is the slightest doubt, the punishment is swift and vicious. Britain is already heavily dependent on foreign buyers of government debt, and even at today’s historically low rates, debt costs are forecast to rise from 30 billion in 2008/09 to 43 billion pounds in 2010/11. They will go much higher thereafter.

By 2014, debt is forecast to reach 80 percent of GDP (currently around 1,400 billion pounds), and the combination of new issuance and the Bank’s programme of buying in existing stocks mean that even a 1 percent rise in interest costs would absorb all the savings from the Conservatives’ painful pension proposals. Meanwhile, on the other side of the world, there’s an indicator of what’s ahead. 

On Tuesday Australia became the first OECD country to raise interest rates, as the central bank worried about a resurgent housing market. As the recovery in far eastern markets gathers pace,  others are expected to follow, offering more attractive alternatives to sterling while UK rates are close to zero. A rise may not be as far off as most forecastsers suppose.

The shape of the Conservatives’ plan for coping with their baleful inheritance is becoming a little clearer. The hope is that concessions on National Insurance will encourage small employers to create jobs and stem the rise in unemployment, while the promise of meaningful spending cuts will reassure foreign holders without scaring the voters back to Labour.

There are, as the Taxpayers’ Alliance spelled out last month, many areas where spending could be cut without hurting more than the small, vociferous groups whose interests would be damaged. One that the analysis missed was government economists: there are one thousand of them.

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