Expert View: Gordon plays the waiting game

The main interest in Gordon Brown's seventh Budget lies in the forecasts rather than in the tax measures (relatively few and slight, thank heaven). The UK has come through the world recession better than most, not least because of an injection of government borrowing worth 1.7 per cent of GDP in 2001-02 and a further 2.3 per cent in 2002-03.

These injections of demand, plus cuts in interest rates, ensured the UK was top of the G7 growth league in 2001 and third (behind the US and Canada) last year. Our relatively strong performance also reflected the remarkable buoyancy of household spending – retail sales growth averaged more than 5 per cent in real terms in 2001 and 2002. This spending was supported by increased household borrowing, underpinned by the strong housing market.

This was to have been the year when a turnaround in the world economy took some of the pressure off the doughty UK consumer. Alas, it hasn't happened. One reason is that the oil price, which fell from nearly $30 per barrel to under $20 in 2001, climbed back to $35 before falling again to $25. Another is that world stock markets have registered a third year of falling prices.

The growth champions of the 20th century are in difficulty: Japan is mired in debt deflation, while Germany, still struggling with the effects of reunification, has too high a cost base. The only bright spot is North America, but even there growth has fallen back in the past six months.

So the UK needs, for the third year in a row, to generate domestic demand to keep output rising. Unfortunately both the main engines of past growth will provide a reduced impetus going forward. For while the Chancellor's forecasts show continued net borrowing of £27bn in 2003-04 what really matters is the change in borrowing. In 2002-03 it increased by £24.4bn (from -0.4 to +24), whereas in 2003-04 it will increase by only £3bn (from 24 to 27).

The private sector is just starting to feel the impact of the increase in national insurance contributions, at a time when consumer confidence has already fallen as sharply as it did in 2001 at the onset of recession. The fall is not surprising given that house prices have decelerated sharply and appear to have peaked in London.

Business confidence has also fallen back, and the well- regarded purchasing managers' index of business activity has moved into negative territory. Manufacturers are suffering from a pound that remains obstinately strong, and from lack of demand in the eurozone.

Against this background it is not surprising that output growth has slowed sharply in the last two quarters, and the Treasury has revised its growth forecast for 2003 downwards by 1 per cent since this time last year. Less economic activity means less revenue, which is why the Government is now projecting six years of unremitting £20bn-plus deficits.

Given the economic gloom, Gordon Brown was surely right to offer a neutral Budget. If the deterioration in the public finances continues, he will one day have to tackle it with tax increases or spending cuts. But this is not the moment. A further large tax increase would have destroyed confidence and ensured an economic downswing.

Instead, the Chancellor has chosen to assume that the growth that has gone missing from 2003 will resurface, bringing borrowing down in due course. His claim that he is balancing the current budget (excluding capital spending) over the economic cycle remains credible, but only just. When recovery comes, the Chancellor's first priority must be to re-establish his reputation for prudence by taking some hard decisions.

Dr.bill.robinson@uk.pwcglobal.com