IMF tells Brown to cut spending and raise rates

World's financial watchdog brings Chancellor back down to earth after his speech to Labour conference
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Gordon Brown's reputation suffered a blow yesterday as the International Monetary Fund urged him to cut spending or raise taxes, just days after his barnstorming speech praising his economic record to the Labour Party conference.

In a three-pronged warning, the world's financial watchdog also urged the Bank of England to raise rates to head off inflation and urged homebuyers to take "particular caution" before entering the property market.

The IMF, run by managing director Rodrigo Rato, said the Chancellor risked breaking his "golden rule" and that he needed to start taking action next year, the most likely date for a general election.

In its keynote world economic outlook, the IMF cut its growth forecasts for the UK by 0.1 percentage points for this year and next, taking its forecasts to 3.4 and 2.5 per cent respectively. This leaves the IMF well adrift from the Treasury's optimistic forecasts for growth of between 3.0 and 3.5 per cent next year, which is a key support for the Treasury's forecast that it will cut the burgeoning public sector deficit.

"Following the large increase in the fiscal deficit in recent years, some consolidation is expected in 2004, mainly reflecting higher revenues," it said. "In 2005 and beyond, stronger fiscal consolidation than presently seems in prospect would be desirable, both from a cyclical perspective and to reduce the risk of a breach in the golden rule in the future."

James Morsink, the head of the IMF's forecast division, acknowledged that the fund was demanding fiscal tightening in an election year but declined to say whether it should come as tax rises, spending cuts or charges for public spending. "We are not sure the measures have been put in place to achieve these objectives," he said. "This is the time to define these measures."

The warning will be particularly unwelcome as it revives memories of the last Labour administration in 1976 when the UK was forced to go cap-in-hand to the IMF for a loan

But sources at the Treasury were unruffled, saying the IMF had been forced to revise up its 2004 growth forecasts from 2.6 per cent. "The UK is currently enjoying the longest period of economic growth on record. The Treasury has outperformed the independent consensus in forecasting growth since 1995. For this year most independent forecasters have now changed their forecasts to fall in line with the Treasury's," one said.

The Government has already pledged to reduce spending growth and has repeatedly said it will meet its fiscal rules.

The IMF said overall activity in the UK remained "robust" but repeated its warning that the central risk was a house prices crash. "Despite signs of cooling in recent months, prices still appear higher than can be explained by developments in fundamentals," it said. "With interest rates on a rising trend, house buyers should exercise particular caution."

The IMF said there were signs of a slowdown but warned that 40 per cent of all previous booms had ended in a bust. It said that despite higher oil prices, consumer spending remained strong, underpinned by sustained income growth and rising housing wealth.

"While inflation remains low, the economy is now running at close to capacity and cost pressures are increasing; the Bank of England has appropriately raised interest rates five times since November 2003, and a continued 'early but gradual' approach appears desirable."

Its warning came as a slew of data pointed to a marked slowdown in the housing market and consumer spending and borrowing. Official statisticians slashed their estimates for growth in household spending in the second quarter of the year to 0.6 per cent, offsetting a rebound in the industrial sector.

Meanwhile the Bank said the number of homebuyers seeking a mortgage fell to a four-year low of 96,000 in August. Consumer confidence dipped to an 18-month low as householders said they had cut back on plans to make major purchases. This was echoed by a CBI survey which showed the number of retailers reporting a fall in sales outweighed those seeing a rise for first time since March 2003.