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Last Updated: Tuesday, 9 October 2007, 16:16 GMT 17:16 UK
Darling signals economic slowdown
For sale signs
The global credit crunch could hit the UK housing market
Chancellor Alistair Darling has warned that there will be more economic pain because of the world financial crisis.

He says that UK economic growth will slow from 3% this year to 2%-2.5% next year, a reduction from the previous forecast of 2.5%-3% made in March.

Mr Darling said that no one could be sure of the full implications of the current instability, but that it was likely to slow growth in the US and EU.

But he said the UK would grow faster in 2007 than any other major economy.

Some independent economists, however, argue that the chancellor is being over-optimistic.

The chancellor is crossing his fingers and trusting to luck
Andrew Smith, KPMG chief economist

"The chancellor is crossing his fingers and trusting to luck," said Andrew Smith, chief economist at KPMG.

"Mr Darling is betting that any damage to confidence and the housing market will be contained and short-lived, but there is clearly a risk that a downward spiral could develop," he added.

Optimistic forecast

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Mr Darling told the House of Commons, however, that the public finances would still be in a strong position, especially if growth returns to its forecast level of 2.5% to 2.75% in future years.

He suggested that the government's public sector overall borrowing would worsen slightly this year - rising by 4bn to 38bn - but improve in future years, so declining to 25bn by 2011/12.

On the government's preferred measure, net borrowing, which excludes spending on capital projects such as schools and hospitals, the deficit is projected to double next year, from the 4.3bn projected in March to 8.3bn now.

UK GDP growth

And he said that public sector net debt would rise slightly in the next two years, to 38.8%, close to the government's self-imposed maximum limit of 40%, but decline after that.

Mr Darling said that the government would hold firm to its economic framework, including meeting the so-called "golden rule" that current spending and taxes should balance over the economic cycle as a whole.

"We can respond to this global environment - we will take no risks with stability, no risks with unaffordable promises, and respond to the rising aspirations of the British people," he said.

However, Roger Bootle, chief economist to Deloitte, said that it could be tough going for the new chancellor.

"Chancellors can only achieve what the economy allows. We may be entering a new period of hard problems and hard choices."

Extra taxes

The chancellor also announced a big cut in inheritance tax for married couples, which would double the inheritance allowance to 600,000, rising to 700,000 by 2010, at a cost of 1.4bn per year by 2010/11.

NET PRE-BUDGET TAX INCREASES
Capital gains taxes: 900m
Aviation tax: 520m
Residence and non-domicile taxes: 500m
Reduced state second pension: 440m
Net tax changes by 2010/11; Source: 2007 pre-Budget report

But to pay for this, and to cope with the economic squeeze, the chancellor announced a series of tax increases to help balance the Budget.

These include an increase in capital gains taxes of 900m per year, which will hit some income by private equity firms, an aviation green tax worth 520m per year, and a gain of 500m per year by modernising the rules on residence and non-domiciled.

Overall, the chancellor has increased net taxes by 1.4bn a year by 2010/11.

Private scepticism

Mr Darling has used some of the extra money to increase planned spending on health and education slightly - but the growth rate will be still be below the rate of growth of spending in the previous decade.

2008 GROWTH PREDICTIONS
New government forecast 2.0-2.5%
Lehman Brothers 1.7% (2.3%)
HSBC 1.8% ( 2.1%)
Barclays 2.5% ( 2.7%)
NIESR 2.2% (2.6%)
Lombard Street 1.5% (1.5%)
% yearly growth in GDP; previous forecast in brackets

As previously announced, the overall growth of public spending will slow to 2% per year, compared with 4% per year in the previous decade.

But health spending is set to rise by 4% above inflation, from 90bn this financial year to 110bn by 2010/11.

However, other private forecasters have suggested that economic growth might be slower than the government expects, which would put more pressure on public spending.

Some City forecasters expect growth to fall below 2%, and remain low for several years if the economic crisis worsens.

That could put further pressure on the public finances.

Mr Darling announced some 66bn in asset sales and productivity savings by central governments, which - if realised - could give him some more room for the expansion of spending.

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