Osborne warned austerity policy may be too harsh

Chancellor's strategy called into question as national debt approaches £1trn mark

(Alan Davidson)

The Chancellor may have to revisit his deficit reduction programme, the Treasury has been warned, as the latest figures on Government borrowing suggest that official forecasts may be too optimistic.

The Office for National Statistics reported yesterday that the shortfall between tax revenues and spending was £10.3bn last month, against £10.1bn in October last year, when the economy was in the depths of the recession and VAT had been cut to 15 per cent.

The recovery since then, restoration of VAT to 17.5 per cent and £6bn of "immediate" spending cuts by the Coalition was supposed to be driving borrowing down, and the £10.3bn figure was substantially higher than City estimates.

Tax revenues are relatively healthy, up 12 per cent on the year, buoyed by VAT and corporation tax receipts. But public spending is running about 5 per cent higher, and suggests that cutting it as radically as the Government plans may prove even more troublesome than previously thought.

Of immediate concern to the Treasury will be evidence that the cost of servicing the UK's national debt, now approaching the £1 trillion mark, is itself driving borrowing up. Interest payments on the accumulated debt were £3.9bn in October, against £3.3bn a year ago. Graeme Leach, the chief economist at the Institute of Directors, commented: "There is a very real risk the deficit will overshoot, especially if economic growth underperforms in the first quarter of next year. We may then be faced with the Chancellor having to revisit spending cuts and tax hikes in the March Budget. Let's hope not."

The Organisation for Economic Cooperation and Development, the club of the world's most advanced economies, has said that the Treasury may need to reverse some of its tax rises and spending cuts if the economy undergoes a sharp correction.

Over the past three months, borrowing has been higher than the same month in 2009 by at least £600m, despite the emergency budget in June. Experts say that while borrowing this fiscal year may well end up lower than the £148bn the Chancellor expects, the borrowing targets for next year, 2011-12, subsequently may have to be raised – or else the Chancellor will have to announce further cuts to public spending and new tax rises to meet his goals. Such a climbdown would lead to accusations of a U-turn, and add to fears that the Government's strategy could backfire, as have similar austerity programmes in both Ireland and Greece. Samuel Tombs, UK economist at Capital Economics, added: "The real challenges come next year when the Government's austerity programme begins in earnest."