Spending plans will trigger higher rates, warn economists

The Chancellor suffered a double blow yesterday after two top economists said his £50bn spending plan would force interest rates higher and new figures revealed the public finances had plunged into the red.

The Chancellor suffered a double blow yesterday after two top economists said his £50bn spending plan would force interest rates higher and new figures revealed the public finances had plunged into the red.

The head of the respected National Institute and the research director of investment bank Goldman Sachs said the extra money could overheat the economy. Their warnings, given in evidence to a committee of MPs, came a day after it emerged some members of the Bank of England's Monetary Policy Committee fear rates will have to rise unless the consumer economy cools.

Appearing before the powerful cross-party Commons Treasury committee, Martin Wheale, of the National Institute, said the new spending would keep rates and the pound higher. "It's almost certainly the case for interest rates and, as best as one can judge, it's the same for the exchange rate," he said.

David Walton of Goldman Sachs said growth was bound to accelerate when the public sector started hiring staff. "If you see growth much faster than 3 per cent a year, then the MPC would start to worry," he said.

The Treasury has sought to play down the comments, saying the details of the spending review did not change the totals announced in the Budget. This was backed by other senior economists. Robert Barrie at CSFB said the spending review was a "non-event" in macroeconomic and monetary policy terms.

New figures on the consumer economy showed banks' mortgage lending doubled in June, from £1.36bn in May to £2.62bn, the highest figure on record.

Tim Sweeney, director general of the British Bankers' Association, said: "With remortgaging and equity release being popular options for an increasing number of homeowners, it is difficult to see a point when customer demand might cool off." But the Council of Mortgage Lenders said an increasing portion of loans was taken up by homeowners remortgaging to take advantage of falling mortgage rates, rather than new demand.

Separate figures showed the UK's public finances dipped into the red last month. The public sector net cash requirement was £7.7bn, the largest June figure since the series began in 1984 and worse than the £5.6bn pencilled in by economists.

Analysts said it looked poor compared with recent surpluses thanks to receipts from the auction of third-generation mobile phones, but that it did not alter the long-term outlook.

The Government's preferred measure, the public sector net borrowing requirement, recorded a deficit of £2.7bn, taking the total for the financial year to £4.4bn compared with £4.2bn a year ago. The PSNBR spreads the revenue from the mobile phone licences over their 20-year life span.