Prudence gives way to Lady Luck as Chancellor gambles that recovery will build revenues

Prudence gave way to Lady Luck yesterday as the Chancellor rolled over his gamble that the economy is on the brink of a massive rebound that will keep public finances in the black.

There is no chance of a recession and there is no black hole in the Treasury's coffers, Gordon Brown declared yesterday in a robust Commons performance.

Mr Brown ate a small slice of humble pie, giving in to his many critics and cutting his growth forecasts for this year for the second time in five months.

But in a move that one analyst dubbed "double or quits", he stuck to his growth forecast for 2004 and raised it for the following year at a time when most independent observers are cutting theirs.

This allowed him to claim that, despite a sharp increase in public borrowing over the next few years, he will meet his golden rule of balancing the budget over the course of the economic cycle.

But the forecasts were criticised as hopelessly optimistic by independent experts, who said the Chancellor had simply delayed the need for further tax rises to prevent the UK spiralling into deficit.

Mr Brown is forecasting growth of between 2 and 2.5 per cent this year – a cut of just half a point from his pre-Budget report forecast of 2.5 to 3 per cent – and sticking to his bullish forecasts of strong growth of 3 to 3.5 per cent – above the UK's long-term trend – in both 2004 and 2005. This leaves him as one of the most optimistic forecasters in the City, where economists are looking for growth of just 1.9 per cent this year and 2.3 per cent in 2004.

Analysts said not only should he have cut his estimate for this year more savagely, he was being over-optimistic in expecting such a marked rebound so soon. "There is now practically no one in the same ballpark as him," said Alan Castle, UK economist at Lehman Brothers. "For him to be so far ahead of the consensus is probably a pretty dangerous place to be."

The Chancellor said the Government would borrow an additional £18bn over the next five years on top of the £29bn extra borrowing he announced in November. He held back from announcing any further major tax increases – instead doubling up on his high-risk gamble that an economic upturn will spare his blushes.

A Treasury spokesman agreed its forecasts were based on an acceleration in investment and an improvement in the trade position. "The reason we are expecting that to happen is that we see the world economy recovering from the middle of this year as the uncertainties dissipate," he said.

Despite a ballooning deficit Mr Brown said he would meet his fiscal rule that dictates he must balance his budget over the economic cycle. "At every stage of the economic cycle and including in the cautious case we have been able to meet our fiscal rules," he told MPs.

But analysts said Mr Brown had simply delayed the tough decisions until next year when he would have to draw up his spending plans for the three years stretching into the next parliament.

"The Chancellor is still being far too optimistic particularly about growth next year and about public borrowing," said Angus McCrone, a senior economist at the Centre for Economics and Business Research.

John Hawksworth, head of macroeconomics at the accountants PricewaterhouseCoopers, said Mr Brown would need to increase taxes by £10bn – equivalent to 3p on the basic rate of income tax. "He has bought himself some time today by making relatively optimistic longer term forecasts for the public finances, but these tough decisions cannot be put off for ever," he said.

The Budget showed public sector net borrowing (PSNB) for the tax year just ended would come in at £24bn rather than November's £20bn forecast. Going forward, the PSNB, with pre-Budget report forecasts in brackets, rises to £27bn (£24bn), £24bn (£19bn), £23bn (£19bn) in 2005-06 and £22bn (£20bn) for 2007-08. This is much less than the deficits of more than £30bn a year that some economists are forecasting and which would breach the Maastricht criteria for euro entry.

The revisions were entirely due to the new economic forecasts rather than the handful of new measures in the Budget that amounted to a net give-away of just £500m.

According to economists, the crucial issue that remains is whether the current slowdown is a temporary dip followed by a swift rebound, or a structural downturn – a permanent shift in the UK's pattern of growth.

The most obvious impact of the slowdown has been the dramatic fall in revenues. Personal and business tax revenues fell 2.3 per cent or £3.1bn in the first 11 months of the financial year – the steepest fall for a decade.

At the heart of this is a slump in revenues from the City of London, such as bonus payments and financial firms' profits. These have both been cut in the wake of the collapse in share prices.

The Treasury still assumes the markets and the health of the City will rebound to their boom levels –claims dismissed by many.

Meanwhile spending is rising, up 4 per cent last year and an expected 6 per cent in 2004. On top of that £3bn has been set aside for the Iraq war.

Gerard Lyons, chief economist of Standard Chartered bank, said: "The key point is not to criticise the Chancellor's forecasts but to recognise how vulnerable the plans are if the economy disappoints."

But in a confident Commons speech, Mr Brown praised the Bank of England for cutting rates to support growth, while favourably comparing Britain's record with its main economic rivals, such as America, Germany and Japan.