IMF warns Brown will need tax rise to cut deficit

The International Monetary Fund cast doubt last night on the Government's forecasts that a sharp surge in tax revenues will cut the UK's ballooning public deficit. In its annual assessment published less than a fortnight before the Budget, it said Gordon Brown's forecasts were too optimistic.

It also issued a strongly worded appeal to the Bank of England to continue raising interest rates to prevent a "hard landing" for the housing market that could trigger an economic slump.

The report was issued in draft form just before Christmas, but the IMF has hardened its language to take account of changes in the subsequent months.

It urged the Government to rein in the deficits, which the Treasury forecasts will total £88bn over the next three years. It said "new fiscal measures" - tax rises or spending cuts - were needed to reduce deficits faster than the Government forecast in December's pre-Budget report. It said: "Reliance on cyclical effects and a rebound in revenues from the financial sector may not be sufficient to achieve the desired decline in the deficit."

Analysts have criticised the Treasury for forecasting that tax revenues will return to levels seen during the late 1990s dot.com bubble when its coffers were filled by taxes on capital gains, financial company profits and City bonuses.

The IMF called for moderating the growth of spending in areas where current plans involve sharp increases.

However, yesterday's report showed this was not a majority view. Some staff believed that the forecasts in the PBR were "appropriate".

None the less, the comments are an embarrassment to Mr Brown, who maintains his policies are "prudent". The Treasury declined to comment last night.

At the Government's request, the IMF published the submission by Tom Scholar, the UK's executive director at the fund, who defended the Treasury's forecasts. "My authorities are confident about these [revenue] projections and note that they are based on deliberately cautious assumptions," he said. "Furthermore, financial sector incomes are recovering rapidly, suggesting a rebound in tax revenues."

On monetary policy, the IMF welcomed the Bank's decision to raise rates last month and in November but hinted it wanted to see further tightening. The IMF raised its forecasts for growth this year to 3.1 per cent from 3.0 per cent, putting it within the Chancellor's 3.0-3.5 per cent forecast range.