Budget Special: Red Book details give lie to Chancellor's optimism

THE ECONOMY: Economic forecasts

The Chancellor's economic forecasts paint a cheerful picture of short- term prospects for the British economy. According to the Budget figures, the economy will grow faster next year than previously predicted, while inflation will meet the Government's target.

But it remains unclear whether the Chancellor has done enough in his Budget to justify his optimism on inflation over the medium term and to avoid problems emerging in the economy in future.

Officials have revised the growth forecast for next year slightly upwards since the Summer Economic Forecast only five months ago. The Treasury is now predicting 31/2 per cent growth next year, rather than 31/4 per cent, a figure which lies comfortably in the middle of the range of independent forecasts.

After higher than expected inflation last month, the Treasury has increased its inflation forecasts for next year by a quarter point to 2.5 per cent. But the Chancellor claimed with confidence that inflation would meet the Government's target of 2.5 per cent or below, by the end of this Parliament and well into 1998 as well.

These headline forecasts for the next year contain no surprises, and most economists regard them as plausible. However, the Chancellor's optimism about the long-term prospects for the economy, particularly about inflation, was greeted with caution and scepticism in the City. Mike Dicks, Chief Economist at Lehman Brothers, said: "We can't see inflation dropping down below 2.5 per cent next year or the year after."

Disagreement between the Chancellor and the Governor over the outlook for inflation looks set to continue. In contrast to the Red Book, the Bank of England's last inflation report stated that: "Achievement of the inflation target remains elusive."

Even within the Chancellor's Red Book there is evidence of potential inflationary pressures. The amount of money sloshing round the economy (measured by M0 and by M4) continues to expand faster than the levels set in government targets. Meanwhile consumer expenditure is once more expected to be the engine of economic growth this year, rising by 4.25 per cent according to Treasury estimates.

As Neil MacKinnon of Citibank pointed out, "The recovery has been rather unbalanced." Growth that relies predominantly on rising consumer demand rather than investment or rising exports, risks becoming inflationary if the economy can't satisfy rising demand.

The Treasury is ebullient in its forecast for investment next year, claiming that business investment will rise by 10per cent. However, that forecast includes pounds 7bn worth of projects under the Private Finance Initiative. public-sector investment is set to fall by more than 10 per cent, leaving whole economy investment at only 6.25 per cent.

If any of the PFI projects are delayed or do not materialise, overall levels of investment may not live up to forecasts. Moreover, predicting investment is notoriously difficult, as the Treasury and everyone else have been wrongly anticipating a pick-up in investment for many years now. Without adequate investment to boost capacity, inflationary pressures are likely to build.

One outlet for those inflationary pressures could be a widening trade gap.

Fiscal policy won't have a huge impact on the Government's ability to meet its inflation target. Mr Clarke said he was tightening fiscal policy to avoid excessive monetary tightening in future. However, the fiscal tightening is marginal. Borrowing in 1997 will be higher at pounds 19bn than last year's Budget forecast for 1997 borrowing of pounds 15bn. Some in the City fear that without far more drastic action on taxes, interest rates must rise in the new year.