Treasury under pressure to pave way for tax reductions

THE TREASURY is under pressure to make room for tax cuts by cutting public spending plans in this year's Budget in an attempt to rescue Conservative fortunes.

The unexpectedly good combination of growth and inflation figures so far this year could make cuts of pounds 3bn relatively painless.

Sir Norman Fowler, the Conservative Party chairman and a close ally of Kenneth Clarke, the Chancellor, said yesterday: 'Over the next two or three years the opportunity is there with the strength of the recovery, I believe, to come to a reduction of taxation, not an increase of taxation.'

Despite Sir Norman's words, the Government's unpopularity is likely to help unnerve the financial markets this week, following last night's European election results and amid speculation that interest rates may soon rise. Even so, many analysts believe that a change of government would make little difference to the conduct of economic policy.

Some City economists believe that the Bank of England may call on Mr Clarke to raise interest rates as early as this week if Wednesday's average earnings figures for April show the annual rate of increase accelerating much above March's 4 per cent. The Chancellor and the Governor of the Bank, Eddie George, met last week.

City economists on average expect earnings growth to remain at 4 per cent, although some analysts - including inflation optimists HSBC Greenwell - believe it could jump to 4.5 per cent. The headline rate of retail price inflation is expected to fall fractionally from April's 2.6 per cent, while the underlying rate stays at 2.3 per cent.

Both figures are due on Wednesday, when Mr Clarke will make his annual keynote Mansion House speech, in which he will emphasise the importance of keeping inflation low to sustain recovery.

Darren Winder, UK economist at Warburg Securities, said the Bank might favour a rise in interest rates much earlier than the market was expecting to help re-establish the authorities' anti-inflationary credibility.

This had taken a knock from February's quarter-point cut in base rates to 5.25 per cent. But most City economists believe Mr Clarke is unlikely to risk adding the insult of a tax increase to the injury of the Government's electoral problems by raising rates early, with a consensus building that the first increase will come towards the end of the year.

One way in which the Chancellor might be able to forestall higher interest rates would be by tightening the policy screw through cuts in public spending plans in the Budget. This would also have the advantage of pleasing the Conservative right and pulling the public sector borrowing requirement down quickly enough to create scope for tax cuts.

The Budget planning process got under way recently when Mr Clarke discussed prospects for inflation and the economy with senior advisers. The Cabinet will discuss public spending next month when the Treasury has completed its summer forecast of the economy, after which the key Budget strategy meeting of Treasury ministers and advisers will take place at Chevening, the country residence of the Foreign Secretary.

Roger Bootle, page 26