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Last Updated: Wednesday, 12 March 2008, 14:24 GMT
Grim prospect for economic growth
By Steve Schifferes
Economics reporter, BBC News

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The UK economy is facing its biggest slowdown since Labour came to power - and the biggest rise in public borrowing, the chancellor has said.

Chancellor Alistair Darling warned that economic growth in 2008 and 2009 would be slower than the government expected.

He cut his growth forecast for 2008 to 1.75%-2.25%, well below the 2.5%-3% predicted in last year's Budget.

And he warned public borrowing would rise to 43bn next year, rather than falling to 36bn as he had hoped.

If growth is slower than the Treasury projects, then borrowing could easily rise above these levels
John Hawksworth, PricewaterhouseCoopers

But the chancellor was more optimistic than most independent forecasters for both this year and especially in 2009, when he predicts growth will return to its long-term average of 2.25% to 2.75%.

Independent forecasts suggest economic growth is likely to be closer to 2% in 2009, and 1.7% in 2008, with the risks still on the downside.

Budget gap

What is not in doubt is that the slowing economy has had a significant effect on government borrowing.

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Mr Darling said the budget gap would rise sharply from 38bn this year to 43bn next year, and would still be at 38bn in 2009-10.

This is a sharp change from assumptions made just six months ago in the pre-Budget report, when borrowing was predicted to fall to 36bn, and 13bn worse than the Budget prediction just one year ago.

The rise in borrowing means that it will take longer for the government's finances to return to surplus, and meet its fiscal rules.

The chancellor said this meant that fiscal policy "will support" the economic recovery by running a bigger deficit in order to underpin spending and keep the economy ticking over.

However, if the economy is in worse shape than the government expects, these deficits could be substantially bigger.

"If growth is slower than the Treasury projects, then borrowing could easily rise above these levels," says John Hawksworth of PricewaterhouseCoopers.

And Peter Spencer, chief economist of the Ernst & Young ITEM club, predicted that "it is very likely that he will exceed the record 50bn [deficit] set by Norman Lamont."

Higher taxes

Because of the chancellor's larger-than-planned deficits over the next few years, he will have to raise tax receipts in later years if the government is to meet its fiscal rules.

Mr Darling has announced big tax increases in the future, amounting to a 1.8bn increase in total tax revenue by 2010/11.

Alcohol, tobacco and petrol taxes will rise faster than inflation for the next four years.

The Treasury says that by 2010-11, higher vehicle excise duties will raise an extra 735m, while higher alcohol duties will raise an extra 625m, and changes to fuel duty could add 550m.

In addition, capital gains tax changes could raise an additional 1bn.

The slowing economy means that Mr Darling has little room to boost public spending, which is already expected to slow significantly during the course of this Parliament.

His tax increases more than offset the 870m extra in child benefit and other help, which will be offered to families from 2010 to lift children out of poverty.

But Robert Chote, director of the Institute for Fiscal Studies, an independent think tank, said that he doubted the tax increases announced so far would be enough to offset the growing budget deficit.

Who's to blame?

The chancellor blamed the UK downturn on the world economic crisis, especially in the US, where problems in the housing sector have hit credit markets worldwide.

The public finances are in poor shape despite the economy experiencing extended robust growth during Labour's time in power
Howard Archer, Global Insight

He said globalisation had resulted in the fact that "problems in one economy can quickly spread to other countries".

He argued that, with low inflation and high employment, the UK is "more resilient" to withstand the downturn.

But his opponents say that the huge Budget deficit built up during a period of strong growth means that the government has squandered an opportunity to secure its economic position.

Many economists agree.

"The UK economy has serious problems of its own (notably including high household debt levels and an over-extended housing market) while the public finances are in poor shape," said Howard Archer of Global Insight.

This has come "despite the economy experiencing extended robust growth during Labour's time in power", he added.

And the Institute of Fiscal Studies also warns that there are many dangers ahead.

"If the downturn is deeper than expected, if he is over-optimistic about the underlying strength of tax revenues, or if political pressure requires further giveaways, then Mr Darling or his successor may have to inflict more pain than he did yesterday," they say.

Tied hands?

At the same time, the threat of inflation has meant that the Bank of England cannot cut interest rates too fast in order to boost the economy.

The combination of slower growth and rising inflation means that average living standards are likely to stagnate over the next few years.

The expectations of businesses and consumers about the economy have already turned sharply negative.



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