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Last Updated: Monday, 5 December 2005, 17:44 GMT
Deficit widens as growth slows
By Steve Schifferes
BBC News economics reporter

Chancellor Gordon Brown
Is the iron chancellor losing his grip on public spending?
The Chancellor has admitted that the UK economy is growing more slowly than he had hoped after a "tough year".

Mr Brown said it was the doubling of oil prices and high house prices that had put pressure on the economy.

He predicted that the economy would grow by just 1.75% this year - half the rate he had forecast six months ago.

And he has accepted that the public finances will be 5bn worse off as a result - and extended the economic cycle by another two years.

But his tone remained upbeat as he claimed credit for keeping the economy on an even keel.

"We are the first party to achieve eight years of continuous economic growth since 1805," the chancellor told the House of Commons.


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But George Osborne, the shadow chancellor, said economic growth in Britain was now weaker than in 18 of the 25 EU member states, and slower than any major economy except Italy.

And Vince Cable, the Liberal Democrat Treasury spokesman, said that "what the Chancellor has demonstrated is his talent for producing rabbits from hats while disregarding the really big long term challenges."

Mr Brown said that despite the price shocks, inflation remained at its target rate of 2%, compared with an average of 8% in the period before Labour was in power.

"We are on course to meet our inflation target not just this year but next year and the year after that," he said.

Redefining the cycle

Mr Brown played down the effect of the economic slowdown on his public borrowing figures, despite adjusting his total borrowing (PSNB) by 5bn in the current financial year and the next to take into account his lower growth forecast.

Shoppers in Oxford Street, London
If the economy is slowing down, the cycle can be redefined

He now forecasts that the current budget balance will not be in balance until 2007/08, two years later than planned just six months ago.

Mr Brown said he would meet his self-imposed "golden rule" - that current spending and borrowing should balance over the economic cycle - by 16bn.

But he has been greatly helped in reaching this target by his decision this summer to change the definition of the economic cycle - adding two more years and 13bn to the pot.

2004/05: 38.8bn
2005/06: 37bn (32bn)
2006/07: 34bn (29bn)
2007/08: 31bn (27bn)
2008/09: 26bn (24bn)
Public Sector Net Borrowing (Budget estimate, March 2005)
Source: HM Treasury

Without those changes, he would have broken his own golden rule this year.

And in his latest forecast, he widened the cycle yet again, extending it to 2008.

This means that questions about the future budget "black hole" - the long-term sustainability of the public finances - can be delayed yet again.

However, many economists believe that Mr Brown's figures for growth in the future are still too optimistic.

The Centre for Economic Policy Research says that growth is unlikely to return to the 3-3.5% the chancellor has pencilled in for later years.

"We think that with growth under-shooting his forecasts, these will be achievable only by imposing new stealth taxes in the 2006 Budget," it said.

Debt limits

Mr Brown was keen to point out the growing share of government spending that is going on long-term investment - which is outside the "golden rule" of balancing current spending with investment.

"There will be more investment in social and economic fabric in five years than happened in the previous 18 years," he said.

He said investment in capital spending would rise to 26bn this year and 29bn next year - pushing debt levels to 38% by the time of the next spending review.

However, Mr Brown is implicitly admitting that the rate of growth of capital spending will have to slow down in the future if he is not to breach his second fiscal rule of sustainable investment - that public debt should not exceed 40% of the size of the economy.

Pay and spending restraint

Perhaps most significantly, the chancellor called for continued wage restraint, and said the government would keep public pay under control - with a wage offer of just 2% to NHS workers.

The Bank of England is closely watching the next pay round for signs of whether inflationary pressures due to higher oil prices will spread throughout the economy.

And the government is also concerned that productivity in the public sector seems to be falling even as the government invests more and more money into health and education.

So they are sending a clear signal that, in the future, extra spending in the NHS should go on improving services, not raising pay.

And there is no doubt that spending is also set to drop sharply after the 2007 spending review.

The chancellor has assumed that public spending will be growing by just 1.9% per year in the three years to 2010, well below the trend rate of economic growth of 2.5%.

So public sector pay and productivity will become a key battleground for the future.

"Our task is to match investment with reform," Mr Brown said.

And it seems that in terms of public sector reform, he means to start here.

"We can combine a strong economy with opportunity for all," he said.

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