Clarke warned against tax cuts as economy surges ahead

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The Chancellor of the Exchequer was advised against cutting income tax in his Budget next week after a batch of figures yesterday showed the economy romping ahead.

Good news about the economy has delighted ministers, but makes the Government's tax and interest rate decisions increasingly delicate. A tough Budget on Tuesday offers the best hope for avoiding higher mortgage rates, but a reduction in income tax is seen as a political necessity.

Consumer confidence this month has increased to its highest level for a decade. Retail sales continued on their strong upward trend in October after a dip the previous month. Mortgage lending jumped and new consumer loans returned to near-record levels, while total lending surged by more than pounds 7bn during the month.

"The last thing the consumer needs is another shot in the arm from tax cuts," said Alex Garrard, an economist at City bank UBS.

"Will Kenneth Clarke have the nerve to do what he should, and put up personal taxes?" said Martin Weale, director of the National Institute of Economic and Social Research and one of the Chancellor's independent advisers. "If not, the need for higher interest rates will become much more urgent."

Many City analysts now believe Mr Clarke will have to raise base rates again before the likely election date to avoid a further damaging disagreement with the Bank of England.

"The Governor will be pressing quite hard for another increase at the next meeting, and the Chancellor will have to give way in December or January," said David Walton of investment bank Goldman Sachs.

Yesterday brought unmistakable evidence of the strength of consumer spending. A further improvement in optimism about the state of the economy took overall consumer confidence to its highest since 1986, according to the regular GfK survey for the European Commission.

The pick-up in confidence during the past year has been greatest for 16-29 year olds and for men. The balance of optimists over pessimists climbed into positive territory, at 1 per cent, compared with minus 10 per cent a year ago.

The rising tide of "feel-good" showed up in last month's retail sales, which were up 0.4 per cent in volume terms after a 0.3 per cent fall in September. "Rising high street sales show that people have cash to spend and the confidence to spend it," said Angela Knight, economic secretary to the Treasury.

Higher sales of clothing accounted for more than a third of the month's gain, despite a record one-month price increase pushed through by retailers. However, footwear sales were flat after a big drop the previous month.

Another third was due to higher food sales, recovering from their weakness earlier in the year. Furniture and carpet sales accounted for most of the rest of the increase.

Total sales volumes were 4 per cent higher than a year earlier, their fastest growth for two years. The strongest components in year-on-year terms were clothing and household goods.

The housing market also continued to thrive last month. New loans by building societies rose by 27 per cent to pounds 1.5bn during the month, adjusting for seasonal variation, and were more than three times higher than the same month a year earlier. The number of new loans approved increased by a third year-on-year.

The high street banks reported a 50 per cent increase in mortgage loans last month, although the level was only 5 per cent higher than a year earlier. The banks' other consumer lending jumped to pounds 507m, near the summer's record level.

Lending to companies increased too, according to the British Bankers' Association. Securities dealers repaid money but a broad range of other companies increased their borrowing.

"This may well reflect a recovery in capital spending," said Adam Cole, an economist at brokers James Capel.

Total lending to the private sector, which also includes lending by foreign banks, doubled between September and October to pounds 7.4bn. There was a corresponding surge in M4, the broad measure of the money supply, whose annual growth rate climbed from 9.9 per cent to 10.3 per cent. The steady acceleration in broad money growth, although inflated last month by a somewhat bigger than usual impact of gilts repo transactions, is sure to alarm the Bank of England.

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