Brown must choose cuts or tax rises, OECD warns

Gordon Brown will have to raise taxes or cut spending to stay within his "golden rule" on the public finances, a global financial watchdog warned on the eve of the Chancellor's keynote pre-Budget report.

Gordon Brown will have to raise taxes or cut spending to stay within his "golden rule" on the public finances, a global financial watchdog warned on the eve of the Chancellor's keynote pre-Budget report.

The Organisation for Economic Co-operation and Development said the Government would have to take action unless there were a rebound in tax revenues. The warning came just 48 hours before Mr Brown delivers the PBR in Parliament.

British households faced the prospect of three more rises in interest rates by the end of next year to control inflationary pressure, the OECD said. This is a far more aggressive view than in the City, which expects one more hike at most.

The OECD said the deficit would break through 3 per cent of GDP this year, contradicting government forecasts. "In the absence of a spontaneous rise in taxes, additional action may be required to achieve a decisive and sustainable reduction," it said.

It said if the Treasury was right to say the economy is running at 1 per cent below capacity, then faster growth would meet the shortfall without the need for rate rises.

"[But] if the output gap has already closed and potential growth is only 2.5 per cent, as the OECD believes, further fiscal retrenchment would almost certainly be required to ensure the golden rule is met," it said.

Meanwhile Mervyn King, the Governor of the Bank of England, which agrees the economy is close to capacity, said it was vital Mr Brown meet his golden rule - that he borrow only to fund investment over the economic cycle. "It's not an option or an extra, it's an integral part of the macroeconomic framework and I'm sure the Chancellor agrees with that," he told a committee of MPs.

A spokesman at the Treasury said the Government believed the economy would not return to full capacity until 2006. "We are meeting our fiscal rules across this cycle - as we will across the next - and all our spending plans, set out to 2008, are fully affordable," he said.