The Fiscal Cost of Higher Rates

A government’s interest bill rises when debt issued at older, lower interest rates comes due and is replaced with new debt at higher interest rates. Since governments typically lock in borrowing costs for years, only a portion of their outstanding debt is exposed to current market rates each year. As debt rolls over, higher interest payments gradually increase the government’s borrowing costs. The speed of adjustment depends on when existing debt comes due for repayment and the pace of new borrowing. Put simply:

∆ interest expense ≈ ∆ yield × (refinanced debt + new borrowing)

This framework provides a useful way to compare how much government interest costs rise when borrowing rates increase across major economies. Graph 1 estimates the impact of a 100bp increase in borrowing costs, while graph 2 uses the average year-to-date rise in bond yields in each jurisdiction.

Our calculations are based on the stock of general government debt (total debt owed by all levels of government) at the end of 2025, bills and bonds maturing in 2026 and projections of new borrowing for 2026 by respective government agencies. For graph 3, the increase in interest rates is measured as the mid-point of the year-to-date rise in 2‑year, 5‑year and 10‑year government bond yields. These estimates capture only the first-year impact. They exclude the cumulative effect that would emerge over time as a larger share of debt is refinanced at higher rates.

The results show that some governments are much more exposed to higher interest rates than others. The United States appears most exposed to higher funding costs, followed by Japan, Italy and France. For the US, a 100bp increase in borrowing costs would raise annual interest payments by roughly US$85 billion in the first year, equivalent to 1.4% of 2025 tax revenue. That is notable given that the federal government already devotes about 20% of tax revenues to paying interest. At the other end of the spectrum, Sweden, Australia and Germany appear less affected by higher borrowing costs, reflecting a combination of lower debt levels and debt structures that are less sensitive to higher interest rates.

Canada falls in the middle of the spectrum. The table below examines the federal government’s exposure to higher interest rates. We estimate refinancing requirements using the maturity profile of outstanding Government of Canada bonds. We assume the current debt management strategy is maintained, and deficits evolve broadly in line with Budget 2025 projections. For the interest rate shock, we assume the year-to-date increase in bond yields is permanent.

Under these assumptions, federal interest expense rises by roughly C$1.6 billion in 2026. The first-year impact is modest because a portion of the government’s funding was locked in earlier this year at lower yields. The cumulative increase in interest costs reaches approximately C$11.2 billion by 2030, equivalent to around 0.3% of 2025 GDP. In our view, the increase is not large enough to significantly change Canada’s fiscal outlook.