By far the most expensive bills that British chancellors tend to land us with are not changes in taxation, but mistakes in macroeconomic policy

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The Independent Online
T he run-up to the Budget is normally one of the duller periods in the markets. It was as true when the Budget was held in the spring as it is now that it is held in the autumn. The City rarely tries to anticipate the details of a Budget.

After all, the Chancellor does hold most of the cards. Apart from Nigel Lawson's decision to abolish tax relief on life insurance premiums 10 years ago, which was accurately forecast by one leading daily newspaper, it is a long time since there has been a seriously accurate pre-Budget leak that would have been profitable to act on in advance.

True, the parameters of some humdrum things, such as the increases in rates of duty on beer, cigarettes and petrol, can usually be safely taken for granted. But those that tend to really hurt, like the imposition of VAT on electricity and gas, are chosen by chancellors precisely because they are effectively difficult to circumvent. There is nothing easier, after all, in a fiscal crisis than to plonk an extra tax on something for which there is no real alternative.

It is only capital taxes that tend to be truly discretionary, since those who have to pay them are usually smart or rich enough to know how to avoid them. This year there is unlikely to be anything to fear on this score, given the Prime Minister's commitment to trying to phase out both capital gains tax and inheritance tax over time.

Of course, by far the most expensive bills British chancellors tend to land most of us with are not changes in taxation, but mistakes in macroeconomic policy.

Unlike marginal changes in duty on beer or fags, a serious misjudgement on the direction of the economy can have a hugely adverse effect on the level of growth in the economy, or on inflation or interest rates - three key variables that have the capacity to impoverish all of us. In fact, this looks like being one of those years when most investors can approach the Budget in a relatively sanguine frame of mind.

The stock market is strong, inflation is still subdued (as this week's impressive retail price index figures confirmed) and both tax cuts and interest rate cuts now look to be on the way - one sooner maybe, the other later.

The biggest issue about the Budget this year is how far Mr Clarke will feel able, or obliged, to encourage extra spending in the economy in order to try and win the next election for his party.

How much room for manoeuvre he has is, as always, the subject of fierce debate among the pundits. Estimates range from pounds 2bn to pounds 5bn or more.

The spin doctors, you can be sure, are already hard at work on the messages to convince us that, whatever the actual changes proposed on the day, it justifies us all starting to feel good again.

A useful rule of thumb, favoured by some of the smartest investors, is that the initial press reaction to a Budget is usually wrong. Thus, Mr Lawson's disastrous giveaway Budget before the 1987 election, which stoked up inflation to 10 per cent and exacerbated the succeeding slump, was greeted at the time as one of the greatest triumphs the post- war period.

Geoffrey Howe's 1981 Budget was famously billed as one of the worst, yet is widely interpreted as a turning point now.

This year, all we know for certain is that the Budget will be made to sound good to voters. Mr Clarke will make sure of that.

The true bill will only come in later, probably after the next election, and may well be less palatable. Even then, this year's Budget will only be one small piece in a general economic and monetary picture that is increasingly geared towards securing victory for the Conservatives at the next election.

Does this all sound too cynical? Maybe, but history teaches investors to count a chancellor's largess with one hand while totting up the longer term consequences with the other. In the short term, this looks like being a Budget that will be good for the stock market.

Shares tend to like a moderate pre-election boom. The gilts market may be more wary, but with interest rates set to fall by the end of the year, that too is likely to help valuations in both markets. Investors should sleep easy.

Meanwhile, over the Atlantic, a much more important budgetary process looks to be afoot. The showdown between President Bill Clinton and the Republican majority in Congress is grand political theatre. Large chunks of the Federal government machine were closed down this week with some 40 per cent of employees sent home.

The Statue of Liberty was closed to visitors, and the White House, poor souls, had to make do with just one chef on duty, instead of four. Most economic statistics will not appear until the Budget dispute is resolved.

The Treasury has avoided defaulting on its debts for the moment. But only by dint of "slicking plaster" devices, such as suspending payments in two Federal government pension funds - "doing a Robert Maxwell," as Robert Aspinall, the market strategist at broker Panmure Gordon, jokingly dubbed it this week.

How long it can continue to do so is not clear, though the consensus is that these measures could hold the line until Christmas, if the dispute lasts that long.

The markets have convinced themselves that the struggle in America for control of the budget process is unlikely to lead to the US government defaulting on its debt obligations.

It would indeed be an astonishing turn-up for the books if it did. The US government is the linchpin of the world financial system, and the yield on its bonds is one of the key factors affecting interest rates around the world.

The US bond yield would certainly rise it there was even the slightest suspicion that the US might welsh on its obligations. With world interest rates already at historically high level in real, or inflation adjusted terms, the bill for fiscal irresponsibility would then certainly spill over here.

On the other hand, if the result of the current stand-off in Washington is a genuinely workable agreement that goes even part of the way towards reducing the US budget deficit, then that is certainly a prize well worth going for. There is a well-documented correlation between the level of government deficits and interest rates.

Whatever the outcome of the shenanigans in Washington, the chances are that it will end up having a much bigger impact on investors here than anything Mr Clarke comes up with at the end of the month. A lasting solution to the interminable budget crises in the US could actually do more for shares here than the Chancellor possibly could.

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