Gordon Brown suffered an embarrassing reprimand yesterday when the world's leading financial watchdog described last month's Budget as "regrettable".
An extraordinary row broke out between the International Monetary Fund - whose key committee is chaired by the Chancellor - and the Treasury after the IMF said interest rates would have to be raised even further because of expansionary measures in the Budget.
In its twice-yearly "World Economic Outlook" the IMF said there were worrying signs of inflationary pressure in the UK economy. It said it was important the Government did not make the position any worse through its fiscal policy - cutting taxes or increasing spending.
"In this regard, the recently announced budget for 2000/2001 appears to be regrettably pro-cyclical," the report said. This line, hugely embarrassing for the Chancellor, was inserted at the last minute. It is believed that Stanley Fischer, acting head of the IMF, telephoned Mr Brown to explain the decision.
At a news conference yesterday Fleming Larsen, deputy director of the IMF's research department, said that with the economy growing so strongly, fiscal policy should ideally "lean against the wind and not contribute to this growth.
"At the margins, the budget contributes to domestic demand growth over the coming years. It is going in the wrong direction from the perspective of easing pressure on monetary policy and the exchange rate," he said.
Michael Mussa, IMF research director, said: "Ideally in these circumstances, it would be desirable for fiscal policy to take some of the burden off monetary policy and move in a tighter rather than an easier direction. That has not happened and I would characterise that as regrettable but not catastrophic."
The Treasury said it disagreed with the IMF's view and would brief the Fund on the Budget as soon as possible. "To say that the last Budget is pro-cyclical, when we are taking a tighter fiscal stance, is quite bizarre," a spokeswoman said. "The Bank of England has had two opportunities to raise rates since the Budget and has not done so. We have not had the opportunity to talk to the IMF and fully discuss the Budget, and we will be doing that."
The Organisation for Economic Co-operation and Development is set to make the same criticism in a report in June. The reports will cement a growing consensus that the Budget has added to the pressure for interest-rate rises.
Mervyn King, a deputy governor of the Bank of England, last night said the Bank's interest-rate setting committee had been fully briefed on the Budget, which did not have any significant implications for inflation.
The IMF revised up its forecasts for the UK economy, which it said would grow by 3 per cent this year and 2 per cent in 2001, up from 2.1 and 1.4 per cent respectively. Inflation is forecast to stay below the Chancellor's 2.5 per cent target over both years.
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