A Budget hold-up

The Budget is almost upon us, and inevitably the financial markets are looking to it for direction. While it is pointless to speculate on the detailed contents this close to the event, it is worth noting that this will probably be the Budget that seeks to delay the economic recovery, not to advance it.

When the base rates were lowered on Tuesday everyone assumed, quite rightly, that this was part of a 'rebalancing', as Norman Lamont used to say, of fiscal and monetary policy. Monetary ease equals fiscal tightening. Accordingly, there is widespread expectation of a tougher Budget next Tuesday than had been expected ahead of the cut. What is not in the markets' perception is that the strategic aim of the Budget, aside from establishing a path to something close to fiscal balance, will be to damp down the economy.

It is not politically correct to say so, but there may soon be a real danger that the domestic economy is expanding too fast. That may be the conclusion towards which the Bank of England has been drawing in recent weeks.

It would not go as far as arguing that there is any danger yet. There is far too much slack in the economy to be worried about that. But it has noted a number of signs suggesting that growth this year will turn out to be substantially faster than present official forecasts suggest.

These signs include, naturally, the rapid growth of narrow money, which has been rising at an annual rate of close to 7 per cent since the summer. Year on year, it is up more than 5 per cent. This is supported by anecdotal evidence that the Bank has been receiving from its regional offices, which are reporting good domestic trading conditions.

True, borrowing by companies has not risen as sharply as one might expect at this stage of the cycle, but firms seem instead to have been running down cash balances quite sharply since the summer, and financing expansion that way. Finally, the Bank is known to take the movement of house prices seriously, so the bounce in the past three months will carry a message for it.

To all this must be added the effect of the structural changes in the economy since the last recession. One is that manufacturing is relatively smaller and private-sector services relatively larger. In as far as one can generalise, services tend to be able to expand output more rapidly than manufacturing - they do not need to plan so far ahead, and need less investment to do so. But frequently, the conventional measures for the economy do not pick this up. All economists look at retail sales (which, incidentally, have also been strong) but they look less at the purchases of service items.

Indeed, much of the growth in the economy may be taking place in areas that, by their very nature, are hard to monitor: small-scale private-sector services such as taxis, restaurants and hairdressing. It is also happening in areas that hardly existed in the early 1980s, such as cable TV. Where one can measure output accurately - for example, in the number of people going through Heathrow - there is clear, solid growth. The trend in unemployment would further confirm this view of a solid upswing.

A second structural change, not so much in the economy but rather in the world economic environment, is also of enormous importance. This is the disappearance of inflation. We are in effect very close to zero inflation now. If you adjust for the incremental improvement in quality that comes through each year in manufactured goods, and increasingly in many services, inflation of 1 or 2 per cent can be ignored. Things may cost 1 or 2 per cent more, but they are 1 or 2 per cent better. Naturally, since some items are still increasing in price, others must be falling.

It is quite difficult for people to envisage growth under conditions of falling prices - when in money terms things seem to be going down, but in real terms things are coming up. But for parts of the economy this is already true. We are used to adjusting for inflation by deflating the money figures, but not the other way round.

If the economic signs point to an attempt to quieten things down, so too do the political ones. This is a very simple point, but it bears repetition. The Government does not want to repeat the experience of the last election, fought at the bottom of recession. It will seek to delay recovery so that it is in full swing in another three years' time. Budgets may not have as much effect on real economic life as they are popularly supposed to do, but at the margin they still have some effect.

This will therefore be seen as a Budget that leans against the recovery. The real parallel may well turn out to be with Lord Howe's Budget of 1981, when he raised taxes in the teeth of recession.