City fears Clarke tax cuts would raise mortgage rates

Economy: Observers warn pound may be undermined by a consumer- friendly Budget though Government says third-quarter expansion slowed to 'sustainable' level

Economists yesterday voiced concern that expected tax cuts in the Budget on 28 November could jeopardise reductions in government borrowing. Even though most expect the Chancellor to press ahead with tax reductions that will benefit consumers, few think there is a good economic case.

Kate Barker, chief economist at the Confederation of British Industry, accepted that growth had turned out to be slower than expected earlier this year. But she said: ''We hope for a tight Budget that will leave scope for a cut in interest rates.''

Ms Barker added: ''The Chancellor may be able to produce tax cuts that will put some money in consumers' pockets within a tight Budget, but by increasing the costs on business.''

Andrew Sentance, who is in charge of economic forecasting at the London Business School, said the Chancellor faced a dilemma. Consumers had been hit by last year's tax increases and there was a case for easing that burden. ''But he is constrained by the fact that government borrowing has turned out so much higher than expected,'' said Mr Sentance.

So far this financial year the public sector's cumulative borrowing requirement has reached pounds 20.4bn, pounds 300m more than at the same stage last financial year. The Chancellor would need to find about pounds 2bn a month from now until March in order to meet this year's target of pounds 23.6bn. City economists expect the PSBR to be around pounds 30bn instead.

Stephen Lewis, director of research at the London Bond Broking Company and the doyen of City of London economists, said: ''A cautious Chancellor would do very little in this Budget.'' He said big tax cuts would undermine sentiment in the markets and put the pound under even more pressure. ''The price of tax cuts could be higher mortgage rates.''

Steven Bell, head of research at Deutsche Morgan Grenfell, said: ''For choice, I would leave fiscal policy unchanged.'' But he said that pounds 4-5bn in personal tax cuts would not have much impact on the economy. ''We're going to get a Budget focused on the voter, and that means the consumer,'' he said.

One City economist who accepts that there is some need for tax cuts, however, is Roger Bootle of HSBC Markets. ''There is a significant danger of a serious slowdown in the economy without a policy stimulation,'' he said yesterday. He would prefer that to come from lower interest rates, as the balance of economic growth needed to be directed towards investment rather than consumer spending. But Mr Bootle said there was a political imperative for tax cuts.

Professor Richard Layard of the London School of Economics argued that the top two priorities should be a scheme to get people out of long-term unemployment and an expansion of education. ''If we are to have a vibrant economy we must have more investment in people,'' he said. His measures would involve extra public spending rather than tax cuts, although savings on benefit payments to the unemployed would offset some spending.