Higher inflation drives jump in UK budget deficit in May

By David Milliken

LONDON, June 19 (Reuters) - British government borrowing jumped much more sharply than expected in May as higher inflation pushed up the cost of servicing index-linked debt, in unwelcome news for the public finances.

Britain's government ran a budget deficit of £23.3 billion ($30.7 billion) in May, up 30% on a year earlier, official figures showed on Friday. That was above all economists' expectations in a Reuters poll which had pointed to a little-changed reading of £18.5 billion.

Britain has historically issued much more index-linked debt than other countries. This debt links interest payments and the amount to be paid back to the index of retail price inflation, which was 3.1% in May and is set to rise further.

In March, before the impact of the U.S.-Iran war was clear, the government's budget watchdog forecast Britain would run a £115.5 billion deficit in the 2026/27 financial year, equivalent to 3.6% of national income and down from 4.3% in 2025/26.

But Friday's data showed that for the first two months of the financial year, public sector net borrowing was 24% higher than in 2025 at £46.3 billion and was £8.9 billion more than the Office for Budget Responsibility forecast in March.

"Several questions remain over whether the current plans will be sufficient to reduce public borrowing," said Matt Swannell, chief economic adviser to forecasters the ITEM Club.

Finance minister Rachel Reeves aims to balance tax revenues with non-investment spending by 2029/30 and in March the OBR forecast she had a relatively narrow £24 billion of leeway for that year to do so.

While higher borrowing this year does not directly reduce that leeway or "headroom", it increases the chance that the OBR will say the government is likely to miss its goal in budget forecasts due near the end of the year.

DEBT COSTS RISE MORE THAN 50% OVER THE YEAR

Debt costs in May alone were 54% higher than the year before and the ONS said they were likely to rise further in next month's data. As well as actual interest paid, the monthly deficit figures also factor in the extra principal that will need to be repaid in future due to faster inflation.

As a share of gross domestic product, British public debt is close to its highest since the 1960s at 95%, though the figure is down from a peak of 98% in 2020.  

Last week, Britain offered investors the highest yield since at least 1998 when it sold £9 billion of 15-year debt.

The government is also struggling to finance extra defence spending within existing budget rules and previous promises to other departments, prompting defence minister John Healey to resign in protest last week.

The figures add to the future difficulties that may face newly elected Labour lawmaker Andy Burnham, who is widely expected to challenge Prime Minister Keir Starmer and called on Friday for a "new path" for Britain.

Tax and other government revenues are up 4.1% so far this year, while the cost of benefits including pensions is 7.4% higher and spending on public services has risen 2.9%.

Burnham has said he intends to keep to the existing fiscal rules as well as previous Labour promises not to raise major taxes or adjust the formula that increases state pensions faster, on average, than wages or prices.

Responding to Friday's data, the OBR said government spending on public services in particular was "highly provisional" at this stage in the financial year.

It also said a greater share of tax receipts were due near the end of the financial year than in previous years, partly because of changes to tax on non-domiciled foreign residents.    

($1 = 0.7582 pounds)

(Reporting by David Milliken; Editing by Sarah Young and Catherine Evans)