Public borrowing at a peak, says ONS, but tough Budget awaits

Government borrowing appears to have peaked, according to the Office for National Statistics. As George Osborne put the final touches to next week's emergency Budget yesterday, the ONS reported lower-than-expected figures for government borrowing, giving the Chancellor a handy windfall.

The data showed the Government spent £16bn more than it received in tax revenues in May – about £2bn better than market expectations and an improvement on the previous month.

The news comes just a few days after Sir Alan Budd, the head of the new, independent Office for Budget Responsibility (OBR), said public borrowing over the next few years would be a little lower than previously forecast, though Britain's "structural" deficit – the part that will not disappear as the economy improves – may be marginally worse.

The ONS figures and Sir Alan's modestly upbeat projections are unlikely to deflect Mr Osborne from delivering the toughest Budget since the Second World War, according to many economists. On Wednesday, the Government announced that £2bn of projects commissioned at the end of the last Parliament would be cancelled and £8.5bn suspended.

The central question is how much faster Mr Osborne will want to reduce government borrowing compared to Labour's plans, and whether he will need to raise VAT to 20 per cent.

Most observers think the Chancellor will want to find an extra £24bn or so of spending cuts, bringing the total reduction to £60bn, including the cuts announced in the last Budget by his Labour predecessor, Alistair Darling.

That would help Mr Osborne to deliver his ambition of eliminating the structural deficit in current spending, (that is to say, excluding infrastructure projects such as road-building) by the end of the coalition's current term in 2015. Even so, further tax rises are widely anticipated by the City, including upward movements in capital gains tax, air travel duties, insurance premiums and VAT. About £15bn to £18bn in annual tax increases by 2015 are expected. Labour's last round of tax measures, including the return of VAT to 17.5 per cent on 1 January and the new 50p income tax rate on very high earners, seemed to be pushing tax revenues higher. Unemployment is also lower than feared, as are its associated costs.

The ONS said borrowing for the whole of last year was £154.7bn, which was better than the £156.1bn forecast by the OBR on Monday. The rolling 12-month total stands at about £145bn, suggesting that peak borrowing has passed. The OBR expects government borrowing to hit £155bn this year, against Mr Darling's forecast of £163bn. Net public sector debt, or colloquially, the national debt, is up to £903bn or 62.2 per cent of gross domestic product – a level last seen in the 1960s.

Vicky Redwood, a UK economist with Capital Economics, said: "The rolling total of borrowing appears to have peaked and is actually now falling – on the face of it supporting the OBR's decision to revise down the near-term path of borrowing. But the big picture is that borrowing remains extremely high and the Chancellor will take further action to reduce the deficit. Significant tax rises – probably including a VAT rise – are on the cards."