Time for a Debt Management Review

Recent headlines have painted an alarmist picture of the UK’s debt situation, rife with half-truths and outdated comparisons. Even the ordinarily rational Andrew Neil has succumbed to monetarist misconceptions, claiming that

Investors will not take on any more British sovereign debt without a substantial risk premium

Before drawing flawed parallels between the UK and Germany by comparing borrowing costs within entirely different currency frameworks.

Meanwhile, Faisal Islam at the BBC noted that

Government borrowing costs have hit their highest level in 16 years.

While he offers some context by pointing to the uncertainty of future U.S. economic policies, his analysis still contributes to the broader narrative of misplaced panic.

These commentaries fail to grasp the key issue: the current debt management framework is a relic of outdated policy, ill-suited for the realities of the modern financial system. It’s time to reconsider and update our approach.

The Origins of the Current Policy

The UK’s current ‘full funding’ rule dates back to 1985 when it was introduced to neutralise the public sector’s influence on the M4 money supply.¹ This framework was solidified by a 1995 review long before critical developments like Bank of England reserves, interest on those reserves, and Quantitative Easing (QE) reshaped monetary dynamics. The rule’s foundation—derived from fixed exchange rate thinking and monetarist orthodoxy—does not reflect the operational reality of the UK’s floating exchange rate regime.

The floating exchange rate fundamentally alters how government spending interacts with a currency area. When the government spends, in effect it gives the private sector the money it uses to buy government bonds. At an aggregate level, in the UK, the choice boils down to holding a gilt or a Bank of England deposit. There is no other alternative. This interdependence makes the lifetime price of a gilt a reflection of expected Bank of England deposit rates over the same period.

Yet, the Debt Management Office (DMO) remains shackled by 1990s thinking, issuing long-term gilts into a market seeking shorter durations. For instance, recent ultra-long gilt sales forced the country to lock in a 5% running yield on £2.25 billion—higher than the current Bank Rate of 4.75%. This mismatch is costly and entirely avoidable.

A Call for Policy Modernisation

The DMO should never sell gilts at yields exceeding the Bank Rate. Instead, it should align its operations dynamically with any market preferences for shorter maturities, as determined by current redemption yields. At a minimum, the government should adjust the DMO’s remit to ensure gilt issuance is always cost-effective regardless of market conditions.

Moreover, the outdated full-funding rule, grounded in discredited monetarist beliefs about the M4 money supply, should be scrapped. By default, HM Treasury should leave deficits on the Ways and Means account at the Bank of England, paying the Bank Rate. This approach eliminates redundant cash management processes, saving costs and streamlining operations.

The DMO’s role should shift to reducing this default cost by issuing gilts and Treasury Bills on tap, priced in line with Office of Budget Responsibility (OBR) yield curve projections. It should only issue securities if doing so would be cheaper than the projected floating path alternative, ensuring interest payments on any deficit increase remained within budget.

Conclusion

The UK’s debt management framework is stuck in the past, constrained by Thatcher-era monetarist principles that never applied in the first place. Just as the government recently updated its debt definition from Public Sector Net Debt to Public Sector Net Financial Liabilities, it must now overhaul debt management practices to reflect modern monetary realities. By embracing a more flexible, cost-efficient approach, we can discard outdated constraints and better support the nation’s renewal.

A debt management review is well overdue. Let’s make 2025 the year we move beyond 1990s thinking and embrace a framework that fits today’s economic challenges.

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