Gordon Brown put himself at loggerheads with the Governor of the Bank of England yesterday, blaming increases in interest rates for the slowdown in consumer spending.
Mervyn King, the Governor, said last month the rising tax burden was a key reason, along with rising utility bills, as to why households were spending less.
Challenged on this by Conservative MPs on the Treasury Select Committee, Mr Brown said he believed that "in retrospect the Governor would have talked about interest rates". He said it was significant that rates rose four times in the run-up to a general election, which he said was the first time it had happened in living memory.
"That was bound to be the major factor in affecting consumer spending," he said. "I don't think anybody should be in any doubt that four interest-rate rises was bound to be the major factor in affecting consumer demand in the economy."
Damian Green, a Tory member of the committee, said the Treasury was using tax rises as "old-fashioned demand management". Mr Brown said rate rises were needed to slow the housing market from a peak in annual inflation of 20 per cent. "We had to cool down the housing market and consumer demand in the economy," he said.
Mr King said last month there had been a "quite sharp rise" of 2 percentage points in the ratio of taxes to household disposable income in the past couple of years. "In the second half of 2004, disposable incomes were lower in nominal terms than a year earlier, so it was hardly surprising that households had less to spend," he said.
The Bank's Monetary Policy Committee yesterday left the base rate at 4.5 per cent, as widely expected by analysts and business leaders. There was no statement with the decision and the City was left divided over whether there would be a rate cut in the New Year.
Royal Bank of Scotland said it expected a cut in early 2006. "We continue to view the risks as skewed to the downside," said Ross Walker, its UK economist. "Growth remains below trend and there is little prospect of a rapid acceleration." But Chris Iggo, a senior strategist at AXA Investment Managers, said: "Rates will be left at this level for some time as evidence emerges that consumer spending is recovering on the back of a stronger housing market."
The Bank is forecasting a rebound in growth next year to 2.5 per cent and over 3 per cent in the following years, although most in the City think those are too optimistic.
However the Chancellor used the Bank's figures to defend the growth and public finance forecasts in his pre-Budget report against accusations of "over optimism" by the Conservatives.
David Ruffley, a Tory MP on the select committee, accused Mr Brown of using a "spin cycle" when he changed the timing of the economic cycle used to determine his golden rule. He said the Treasury was "running scared" of organisation such as the Institute for Fiscal Studies that had called for an independent body to date the start and end of the cycle.
But Mr Brown said that would take away responsibility for fiscal policy from the House of Commons and run counter to the "whole history of parliamentary democracy". The Chancellor played down the threat of tax increases, saying he would meet his self-imposed fiscal rules, which limit borrowing to the amount needed for public investment over the economic cycle, by maintaining "tough fiscal discipline".
Mr Brown also triggered fresh speculation he wants to reopen the deal between the Government and civil service unions that would allow current public employees to retire at 60. He told MPs: "There was a framework agreement and that is now part of sector by sector negotiations."