Outlook: Brown should stay firm on spending

Might Gordon Brown have turned out to be too tough on public spending for his own good? So determined has he been to consign the Labour Party's tax and spend image to the dustbin of history that it looks increasingly as though he will not just meet but actually beat the Conservative government's expenditure plans this financial year.

This has certainly won over the City. The widespread reaction yesterday was that, with spending control this good, there would be scope to offer higher pay awards to key groups of public sector employees and still keep the PSBR on target. Most analysts have seen pay claims as one of the most likely sources of pressure for government spending, as the wage bill accounts for about a third of the expenditure total. Yesterday's figures suggest that a bit of this pressure can be safely released. Mr Brown won't want to trumpet this from the rooftops but even some one as parsimonious as he must know that a government that keeps stressing the importance of education will one day have to offer the teachers more money.

An extra 1 per cent on the total pay bill would cost another pounds 1bn. Concentrated on particular high-profile groups, it could finance settlements generously in excess of the present going rate, about 3.5 per cent in the private sector. However, the good news on the government's finances is coming a bit early in the negotiations. If the Iron Chancellor is serious about keeping the lid on spending - and he has proved that he is - he needs to persuade all those aggrieved public sector groups that there really is not all that much to play for. His negotiating position would have been easier if the good news on the PSBR had been delayed for another six months.

There is an issue of economic strategy on top of the matter of negotiating tactics. To the extent that borrowing is below target because of the strong economy and falling unemployment, the Government should bank the difference. As Mr Brown pointed out before the election, at this stage of the last business cycle the Government was in surplus. He needs to resist calls to exploit the good news and loosen up on the purse strings, or he will find himself having to rein back again when the economy starts slowing down.

Even so, the public finances are plainly in much better shape than Labour was claiming before the last election. With the problem of the strong pound beginning to recede too, Mr Brown could hardly have hoped for a more benign economic backdrop to the Labour Party conference. He's yet to put a foot wrong and even the City is beginning to say "well done so far".