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banner Friday, 10 March, 2000, 14:53 GMT
The economy: a rosy scenario?

Chancellor Gordon Brown will present his Budget against an extraordinary set of economic circumstances.

Inflation is running below the official target rate, unemployment is falling to a 30-year low of around 1m, and the bright prospects for economic growth are likely to swell the government's coffers.

The UK economy recovered much faster from the recent global crisis than anyone expected.

It is now forecast to grow by about 3% in 2000, higher than in the rest of the EU, after growing by 1.9% in 1999 - above even Mr Brown's seemingly optimistic forecast.

Of course, not all of this is the chancellors' doing.

Outside Germany, the rest of Europe has also seen a strong recovery which has helped British exports, while US growth remains extraordinarily strong.

Two speed economy

But the economy is not growing evenly.

The imbalances in the economy - between North and South, between the service sector and manufacturing, and between skilled and unskilled workers - is getting worse.

Factory workers are not sharing in the prosperit
Factory workers are not sharing in the prosperity
House price inflation is five times higher in London than in the North. Wages in the service sector are growing four times faster than in manufacturing.

The manufacturing sector, which is heavily reliant on exports, have been particularly affected by the high pound, which makes UK exports too expensive in overseas markets.

The government and the Bank of England are concerned that the housing boom will accelerate out of control, but they are reluctant to cool the economy too fast for fear of hurting the Labour heartland in the North.

And it would be politically difficult for the Chancellor to tighten policy - essentially raising taxes - in face of such a huge budget surplus in the year before the election.

What could go wrong?

One of the extraordinary facts about the current situation is the disagreement among economists as to what the main economic danger might be.

Most economists, and the Bank of England, seem to fear a return of inflation, with the economy growing above its long-term trend rate of 2.25%-2.5%.

They believe rising wages and house prices could trigger inflation. House prices in the UK grew by 15% last year, with double that rate in parts of London and the South East. Wages are rising at more than 5.5% annually, above the perceived danger level of 4.5% used by the Bank of England.

Those who foresee this scenario say the chancellor and the Bank of England, should continue to tighten monetary and fiscal policy to slow down the economy.

Others express a different view.

They argue that the economic recovery is quite fragile, while inflation is nowhere to be seen.

They believe prices have permanently adjusted downwards - helped by the internet and the effect of cheap imports.

Such a scenario means the government should give away more of the Budget surplus than it probably will.

They argue that, far from being a bribe, it would be sound economic management.

Managing the pound

Gordon Brown is unlikely to take that course of action, one reason being the possible effect on the pound.

The currency has soared to a level against the euro equivalent to 3.2 Deutschmarks, far higher than when Britain was forced out of the Exchange Rate Mechanism (ERM) in 1992.

Most observers believe that the pound is high because it is linked to the dollar, which has been strong against the euro, rather than because of the intrinsic attractiveness of the UK economy to investors.

If that is so, a collapse in the US which affected the dollar might also affect the pound - boosting import prices and fuelling inflation.

Unfortunately, there is relatively little the chancellor can do.

Interest rates are set by the independent Monetary Policy Committee of the Bank of England, which targets inflation, not the exchange rate.

Luckily, he has a fallback position.

Previously announced "stealth taxes" including the abolition of mortgage tax relief and the married couples allowance, mean that there is already 4bn of fiscal tightening (tax increases) set to take effect in April.

So he could still give away part of his surplus, without further stimulating the economy.

And with luck, the Bank will not have to raise interest rates very much more either. It already says it detects some signs that the housing boom may be cooling.

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See also:

10 Mar 00 | Budget2000
The chancellor's 'war chest'
10 Mar 00 | Budget2000
Tackling tax inequalities
28 Jan 00 | Business
UK growth powers on
27 Jan 00 | Business
UK trade sees record deficit
26 Jan 00 | Business
UK consumers flock to shops
18 Jan 00 | Business
Manufacturing output surges
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