Clarke upbeat on growth and inflation

But pounds 12bn jump in borrowing target takes City by surprise

Kenneth Clarke yesterday held out to voters the promise of faster growth and lower inflation in the next 18 months, while admitting that the economy had not expanded as quickly as he had predicted so far this year.

The Chancellor also said government borrowing this year and next would be pounds 12bn higher than he estimated in last year's Budget, although it would scrape below the upper limit set by the Maastricht Treaty just in time to qualify for the single currency.

Presenting his new economic forecast yesterday, Mr Clarke insisted that the budget was heading towards balance in the medium term, paving the way for the national debt to fall "in due course". But he added: "This year we face a situation where we are going to have to have tight control on public spending." He would cut taxes only if it could be afforded, he said.

Yet Mr Clarke's new target for the public sector borrowing requirement next financial year is so much higher than before that some City economists speculated he was pencilling in a "surprise" tax cut to be announced in November. Others thought the new forecasts still underestimated the scale of the likely shortfall in the Government's finances.

Analysts also said the Chancellor's optimism about inflation paved the way for a further reduction in interest rates.

"He seems to be lining things up to say by the autumn that borrowing is not as bad as we thought, and lining things up for lower interest rates as well," said Michael Dicks, UK economist at City investment bank Lehman Brothers.

Shadow chancellor Gordon Brown criticised Mr Clarke for failing to explain why his borrowing plans were "in tatters". Mr Brown said: "The black hole in the public finances shows that his economic management is neither competent nor credible."

And Labour leader Tony Blair clashed with the Prime Minister in the House of Commons. "Isn't the truth that, having promised you would cut tax, you raised it, and having promised you would cut borrowing, you raised it?" Mr Blair said, calling the Government's handling of the public finances "untrustworthy and incompetent".

However, Mr Clarke was in ebullient form yesterday. "We have never had a better combination of economic prospects," he said, claiming that he saw little danger of anything going wrong with the economy during the run-up to the general election.

The new forecast has downgraded the growth expected this year to 2.5 per cent but predicts growth picking up to more than 3 per cent on average during the next 18 months.

Consumer spending, which was revised up in the forecast, drives the predicted expansion with a 4.25 per cent increase in 1997. This would be the fastest spending growth since the late 1980s boom.

But the Chancellor said a surge in consumer spending did not threaten achievement of the inflation target. "All the other evidence is that inflation is very subdued indeed," he said.

In a remark that analysts saw as creating room for a further cut in base rates after his next monetary meeting with the Governor of the Bank of England on 30 July, Mr Clarke added: "I don't want to pick a quarrel with the Bank, but in the entire time I've been Chancellor their forecasts of inflation have always been wrong and have always been pessimistic."

Yesterday's forecast shows inflation falling below the 2.5 per cent target by the end of this year.

The new Treasury forecast accepts that its previous forecasts for the PSBR have been too optimistic. It has revised this year's target up from pounds 22.4bn to pounds 27bn and next year's from pounds 15bn to pounds 23bn.

One reason for the revision is higher debt interest and social security payments, both outside the Government's control total. These have added pounds 2bn to expected borrowing over the two years.

The bigger reason, however, is lower forecasts of tax revenues amounting to pounds 10bn in two years. Although tax receipts are still expected to rise as a proportion of GDP next year, the Treasury said changes in the structure of the economy meant revenues might not grow as fast as it had initially expected.

It suggested that companies have become "more efficient in managing their VAT liabilities", while the shift towards part-time work helped explain weak growth in income tax revenues.

The Treasury nevertheless managed to predict that Britain would just meet the Maastricht limit of a 3 per cent of GDP budget deficit next year.

The Government's PSBR targets are close to the City average, but the pounds 8bn revision for next year took many analysts by surprise. "It is surprising to see the combination of such a strong forecast for the economy and so little improvement in the public finances," said Simon Briscoe of Nikko Europe.

Adam Cole at broker James Capel said: ''By the November Budget, the Chancellor could well be looking at revising the PSBR forecasts down." It would be the perfect background to announcing tax cuts, he said.