Bank warns Brown over danger of tax shortfall

The Bank of England last night fired a warning shot over the Government's spending plans amid fears that the Treasury will fail to hit its ambitious targets for tax receipts.

Mervyn King, the Bank's Governor, said the improvement in the public finances since Labour won power had been a "key element" in the UK's recent economic health.

In his keynote Mansion House speech yesterday, Mr King said the Treasury's scales were "tilting more towards the spending side. I am assured that the projected rise in tax revenues over the next three years will allow the scales to swing back to what is known in the trade as a sustainable fiscal position," he said.

"This is important because the improvement in the fiscal stance in recent years has been a key element in achieving macroeconomic stability."

Since it was granted independence to set interest rates, the Bank has used the figures in the Budget book when setting monetary policy. March's Budget showed tax take as a share of GDP rising from under 36 per cent now to 38.2 per cent by 2009 - a figure that has raised eyebrows in the City.

If the Government misses its targets it will have to run a higher budget deficit that could trigger a fall in the pound or order fresh tax hikes. Last night Gordon Brown, the Chancellor of the Exchequer, insisted the Government would not relax its fiscal discipline or resort to "quick fixes or short cuts" in its forthcoming spending round.

He also backed the Bank's decision to raise interest rates for two months running for the first time in four years. In comments that will be seen as support for further rises, he said: "With financial markets expecting interest rates to rise around the world as the world economy turns upwards ... we will continue to support our monetary authorities in the difficult choices they have to make."

But he insisted the housing market was "strong", playing down warnings from the Bank of an imminent price crash.

On Monday night, Mr King stunned the housing industry with a warning that house prices might be unsustainable. "It is clear that the chances of falls in house prices over the past year are greater than they were," he said. The Governor, who traditionally avoids stealing the Chancellor's limelight at the Mansion House dinner, toned down his remarks from his hard-hitting speech earlier this week. The Bank last night angrily denied rumours the Treasury had forced Mr King to cut them from his speech.

Last night, he reiterated the Bank's "reasonable central view" that growth is likely to be robust over the next year. "As far as we can tell, there does not appear to be much spare capacity in the UK economy," he said.

His comments came as official figures showed the labour market had continued to tighten. Unemployment tumbled to a 29-year low in May while the number of people in work rose to a new all-time record. The demand for staff triggered an acceleration in growth in pay rates above the threshold that the Bank believes is consistent with low and stable inflation.

The number of people out of work and claiming benefit tumbled by 12,000 to 862,000 in May, the lowest level since 1975. The employment level rose by 30,000 in the three months to April to 28.3 million. Annual earnings growth in April accelerated to 4.7 per cent from 4.3 per cent in March. Excluding the impact of the current volatile bonus season, average earnings growth over the past three months rose to 4.3 from 4.1 per cent.

Analysts said the figures showed the UK was embarking on an economic recovery with little spare capacity in the labour market and would justify a rate hike in July or August.