Buoyant start heralds rate rise after election

A new Labour government will have to raise taxes and interest rates to prevent the economy overheating and reduce government borrowing, according to New Year forecasts published today.

The predictions coincided with fresh evidence that 1997 is opening with a swing, with a survey showing business confidence at an all-time high and many companies planning to raise prices. Retailers reported that the January sales had got off to a flying start.

The shadow Treasury minister Alan Milburn yesterday predicted a new start for the economy with a new Labour government. The recovery, he said, was "threatened on every side by Tory economic failure".

The party produced a dossier on the Conservative Government's economic record, claiming that "ordinary families have been left pounds 2,120 worse off in tax terms by the 22 Tory tax rises since the last general election".

Mr Milburn added that inflationary pressures were growing and interest rates rising.

Increasing the cost of borrowing might have to be one of the first acts of an incoming government if consumer spending accelerates between now and the election, according to a new report out today from independent consultancy Cambridge Econometrics.

It notes that if Labour does win the election, the party will inherit an economy in far better shape than its predecessors in 1974 and 1979 enjoyed. Even so, tax increases would be needed to bring government borrowing under control and finance its spending plans, the report predicts.

"Politically, the best time to introduce these is as early as possible after the election. Fortunately the timing is also likely to be right from the viewpoint of the macro-economic background," it says.

A separate forecast from the City investment bank Goldman Sachs makes the same diagnosis. It says that although nothing dramatic should go wrong with the economy in 1997, there will be signs of overheating in a widening trade deficit and faster earnings growth. The strong pound will help keep inflation close to the Government's 2.5 per cent target but at the expense of export growth.

Unemployment is likely to fall below 1.7 million by the end of this year and to 1.5 million by the end of 1998, Goldman Sachs predicts.

"We expect the next government to take early action to ensure that the period of overheating is quite short-lived," write the report's authors, David Walton and Martin Brookes.

The Goldman Sachs report predicts a lower-than-expected shortfall in government finances in the present financial year thanks to buoyant growth, but says that by the time the economy slows back to its normal trend, the Public Sector Borrowing Requirement will be too high for comfort on unchanged tax and spending plans.

The likely need to raise interest rates will take the shine off record levels of business confidence, according to a survey of medium-sized companies by Lloyds Bank Commercial Services.

The survey shows optimistic businesses planning to increase employment by more than at any time since the question was first asked in 1993. The upturn during the past six months has been centred on services, especially transport and communications and hotels, catering and leisure.

But much of the upsurge in confidence is down to plans to raise prices and increase profit margins, the survey shows. The balance of firms raising rather than cutting prices during the last six months had been the lowest since mid-1993.

Michael Riding, managing director of commercial banking, said: "Middle- market companies increasing prices in the coming months will stoke inflationary pressures."

The resulting upward move in interest rates would dent confidence, he predicted.