Inflation and Fiscal Stability: The Case of the United Kingdom
Debt, Deficits, and the Return of Market Vigilance
What happens when a central bank cuts rates and inflation goes up instead of down?
The United Kingdom is starting to look worryingly familiar to those who study the interplay between debt, deficits and inflation. Since the summer of 2024, the Bank of England (BoE) has cut its policy rate by 125 basis points. Over the same period, inflation rose from about 2% to 3.8% in July 2025.
The U.K.’s public debt ratio now stands at roughly 96% of GDP, nearly identical to that of the United States. Persistent budget deficits and a looming Autumn Budget are heightening fiscal pressures. Markets are taking note: Just this week, the yield on 30-year U.K. government bonds—known as gilts—climbed above 5.7% — the highest in three decades. Unlike the 1990s, however, Britain now carries a much heavier debt stock, making such yields far more dangerous for the public finances.
The Fiscal Bind
The U.K. government has failed in earlier attempts to reduce social spending. The upcoming Autumn Budget is likely yet again to lean on tax increases, which will further stifle growth and erode fiscal space. The government’s fiscal rules are comparatively lax, but even they are proving difficult to meet.
The deeper problem is not the precise mix of tax rises or spending pledges, but the absence of a credible fiscal framework. Without such a framework, markets rightly conclude that public debt will not be stabilized through disciplined budget surpluses but instead be eroded via inflation. That raises the risk of wage-price persistence, embedding higher inflation expectations into contracts and pay settlements.
The government’s longer average debt maturity (about 14 years compared with six years in the U.S.) provides some cushion, but the trend is moving in the wrong direction. New debt issuance is expected to average maturities closer to nine years, leaving Britain more exposed to refinancing risk and higher interest costs over time.
A Familiar Story: Bad Fiscal Policy Breeds Inflation
Liz Truss’s short-lived tax plans and Keir Starmer’s failure to rein in social spending point to the same root cause of rising inflation and interest rates: persistent deficits without serious consolidation plans. Markets are not spooked by ideology as much as by arithmetic. The more borrowing is pushed without credible plans for restraint, the more investors price in inflation as the government’s fallback.
This is not a novel phenomenon. In fact, the Bank of England itself just reminded us of the historical record. In July, BoE staff published a major study, “Muddling Through or Tunnelling Through? UK Monetary and Fiscal Exceptionalism and the Great Inflation.”
The paper, authored by Michael Bordo, Oliver Bush, and Ryland Thomas, argues that the Great Inflation of the 1970s cannot be explained solely by commodity shocks or monetary mistakes. Instead, the persistence of inflation stemmed from a sequence of fiscal regime failures. Successive governments used deficits not to stabilize the public finances but to fund growth pushes, subsidize shocks and appease unions. Inflation expectations adjusted upward accordingly.
Crucially, the authors show that inflation was only brought under control in the 1980s and 1990s when fiscal consolidation accompanied already tight monetary policy. Fiscal regime shifts, not monetary tightening alone, were decisive in restoring credibility.
Why This Matters Now
The echoes today are striking. The U.K. is once again in danger of “muddling through” fiscal imbalances while leaning on monetary easing. Yet the bond market is already signaling doubts. Gilt yields above 5.7% are not merely a reflection of global conditions; they are a vote of no confidence in Britain’s fiscal trajectory.
The lesson, both from history and from current market dynamics, is clear:
1) Monetary policy alone cannot stabilize prices if fiscal policy is persistently irresponsible.
2) Without a credible plan to consolidate deficits and stabilize debt, inflation expectations will continue to drift upward.
3) Financial repression or further rate cuts will not solve the problem; they will deepen it.
As the BoE study concludes, Britain’s past experience shows that fiscal consolidation was indispensable to breaking inflation’s grip. That remains true today. If the government continues to postpone discipline, households and savers – just as in the 1970s -- will ultimately pay the price through higher inflation and diminished growth.
Britain might be offering the United States a case study of why fiscal consolidation plans matter for interest rate and inflation dynamics. Without a credible fiscal anchor, interest rate policy loses its bite, inflation risks becoming entrenched, and markets grow restless. The only cure is the hardest one: genuine fiscal reform. The question is will policymakers ever choose the hard path before markets force their hand?