Hamish McRae: Waiting for a bit of Budget leeway, Chancellor? Don't hold your breath

Economic View

The squeeze is on. It is just over three weeks to the Budget and the glide path to it has become more bumpy.

The Chancellor has had one piece of good news in recent days: tax receipts in January were high enough to nudge the Government's accounts into surplus, leading to suggestions that the deficit this financial year might actually be a little less than forecast.

That may give him a little leeway to reverse some of his most unpopular measures, postponing, for example, the proposed increase in fuel duty. He will need some leeway, for the rest of the economic news was almost universally bad. I'll come to the international situation in a moment. First, the bad news from the home front.

Those bad final-quarter GDP figures were, against all expectations, revised down even further. I still feel something has gone wrong with the numbers and that in 18 months or so we will find that they are revised substantially upwards. Some slowdown has indeed occurred but not that sharp contraction. But that judgement may prove mistaken and, in any case, the very fact that people are talking the economy down will itself undermine confidence.

Coupled with these bad growth numbers came evidence of a further shift on the Bank of England's Monetary Policy Committee, with three members now voting for a rise in rates. Now this should not be seen as bad news – it certainly isn't bad news for savers – but it does confirm my view that the first rise in rates is likely in May and may come even sooner.

The rise will be tiny and the direct impact negligible, but in psychological terms it will be most significant. Everyone knows rates will soon be going up, but there is a difference between knowing something is going to happen and it actually taking place.

You can have different ideas about the wisdom of the Government's fiscal policy and the Bank's monetary policy but one thing is beyond dispute: living standards are being squeezed and will go on being squeezed.

The main graph shows what has happened to real household incomes (i.e. allowing for inflation) over the past 40 years. As you can see, they were all over the place in the dreadful 1970s as inflation surged into double figures, and they fell in the early 1980s recession and less seriously in the early 1990s one. Then they rose solidly through the rest of the 1990s and, at a slowing rate, through the early 2000s.

But what I had not appreciated until I looked at the graph was that real household incomes were stagnant or even falling in the final years of the boom. They are negative now: on average, inflation is higher than wage increases. Chris Watling, of Longview Economics, argues that this decline in living standards is an indictment of attempts to stimulate the economy out of recession by monetary expansion, which have merely resulted in higher inflation – the higher inflation that has cut real living standards.

If people don't have increasing income it is hard for them to increase consumption. If you look at household consumption as a proportion of GDP it has been broadly flat since 1997 at between 64 and 66 per cent of GDP. That is as it should be, for if consumption rises much higher there is not enough room for investment. But public sector consumption has risen steadily since then, climbing from 17.5 per cent of GDP to more than 23 per cent of GDP. To explain: this is the consumption part of total government spending, the other parts being public investment and transfer payments.

Investment needs no explanation but transfer payments are when the government takes in money in tax and then sends it out again in unemployment benefit, pensions and the like.

The point I am making here is not that there is something wrong with government consumption, because that label covers items such as defence and the NHS. It is simply to point out why we are seeing household incomes squeezed: if you spend money on one thing you can't spend it on another.

It does, I am afraid, get worse. It gets worse because of a deterioration in our terms of trade.

During most of the past couple of decades we have been able to charge more for the goods and services we sell abroad while the price of imported goods and services has tended to fall or at least rise more slowly. Relative changes in the prices of exports and imports are the terms of trade, and they were in general tending to move in our favour.

Now, with the surge in oil and other import prices, we are seeing that go into reverse. Think of a rise in the oil price as a tax imposed on our consumers, except that the revenue is going to Opec governments, not to our own.

It is not quite as bad at that because the UK remains a significant oil producer and we are close to balancing demand and supply. But a higher oil price increases costs in all sorts of other ways, and for the developed world as a whole there is no dispute that higher energy prices will slow growth. Put at its simplest, if you have to spend more money filling the car you have less to spend at the supermarket.

So what might be done in the Budget to offset rising oil prices? Not a lot. We don't yet have much feeling for the future direction of oil and other energy prices because we don't yet have much feeling for how the present tensions will be resolved. Global oil supplies appear to have some slack at the moment, but the world economy remains too heavily dependent on oil.

But there is a reasonable case to be made, if there is some leeway in the Budget projections, for the Chancellor to fine tune his deficit-cutting plan so as to reduce the social and economic impact of the surge in the oil price. That plan is robust enough to be able to absorb some punishment – to roll with the punches.

The difficulties we in the developed world face are, of course, nothing when set against those faced by the Libyan people – but the oil price surge does come at a most unfortunate time.

The only way is up: Why a new government will prove Ireland's turning point

A fair wind to the new Irish government, for the Irish people deserve it. As someone who remains relatively hopeful about the Irish economy – to caricature, the economy would be fine if it were not for the property debts – I really do now think that some sort of turning point is being reached.

The reason for thinking this is not so much that the new government will be able to change policy in any radical way; it may able to renegotiate aspects of the EU rescue package, but the substance will stand. No, it is more that the people who get you into a mess cannot get you out – simply because they lack legitimacy. You see this with firms that get into trouble. The old management may well do the right things, but a new chief executive can win a team's confidence in a way the old one never can. Funnily enough, you can see that in Lloyds Bank right now, where the new chief executive, Antonio Horta-Osorio, is already getting to grips with the bank and is hugely impressing senior management as he does so.

There is another parallel. The single most damaging thing the old management of Halifax Bank of Scotland did was to plunge madly into property lending in Ireland. Provisions for losses there were lifted again last week – which came as no surprise as the Lloyds team had been stumbling on more and more ghastly loans. But now it looks as if they have cracked it. They really know the worst. And once you know the very worst, things can only go up.

Since property lending was the what brought the Irish banks, and you might say the government, down, Lloyds' experience shows a more general turning point. Once the tally of bad property debts peaks and starts to decline, the still-strong bits of the Irish economy will start to pull the country through. Then it can renegotiate from a position of strength. There are five tricky years ahead, sure, but you could say that for much larger countries than Ireland.