Public borrowing smashes forecasts to hit record high

FTSE 100 drops 5.5 per cent amid global shares sell-off; Mortgage lending in UK declines 25%

Britain's public finances worsened yesterday as record borrowing figures cast doubt on the Government's ability to counter any fall-off in economic activity.

According to the Office for National Statistics (ONS), net public sector borrowing climbed to £7.8bn last month, the largest Dec-ember shortfall on record, while net borrowing for the financial year to date rose to £43.6bn, £11.4bn higher than in the same period last year and well ahead of the Government's forecast of £38bn for the full year. Higher government spending also drove up the public sector net cash requirement, which touched £16.975bn last month, another record for December.

The ONS data came as the London Stock Exch-ange's FTSE 100 index of leading shares plunged 5.5 per cent, amid mounting fears of a recession in the US and concern that a slowdown in the UK would be a natural concomitant of a sharp slump across the Atlantic. In Germany, the bench-mark Dax index dropped 7 per cent, while Japan's Nikkei fell 4 per cent and Hong Kong's Hang Seng was off 5.5 per cent. The US markets were closed for Martin Luther King Day.

"The public finance figures mean that the Government cannot cut spending as growth slows down and this limits their options, especially if the slowdown is sharper than we expect," said Trevor Williams, the chief economist at Lloyds TSB corporate markets. "The numbers mean that fiscal policy is no longer an effective tool to deal with a weaker economy and we are only left with monetary policy and the Bank of England."

Mr Williams also said the Government was constrained in its options to ease the situation. "They are not in position to cut spending nor can they raise taxes, which are already quite high," he said.

George Soros, the veteran investor, summed up the views of many in the market in an interview with Der Standard newspaper, warning that the US and Europe were threatened by recession, and President Bush's package of measures was unlikely to help. The situation in the financial markets was "much more serious than any financial crisis" since the Second World War, he added.

The Item Club, an economic forecasting group, echoed the views of Mr Williams. The group, which expects growth in the UK's GDP to drop from 3.1 per cent in 2007 to 1.8 per cent this year, said that "one reason why the pound is so weak is that fiscal policy cannot be used to complement monetary policy and support the economy as it was in 2002".

Item Club's Adrian Cooper said the ONS figures, taken together with a rep-ort by the Council of Mortgage Lenders (CML) showing a sharp fall in mortgage lending, made for "pretty disappointing reading". The CML revealed that gross mortgage lending declined by 25 per cent in December to £22.6bn, compared with £29.9bn a month earlier.

"There is widespread con-cern about the economy and here the golden rule is shot to pieces," Mr Cooper said. "The Chancellor, Alistair Darling, cannot use fiscal policy to stimulate the economy which, as the state of the housing market shows, is experiencing some weakness and may well get worse. It's a time when you want to use all the guns in your armoury – the fact that the Chancellor cannot do so is unfortunate." Mr Cooper also said that while the Bank of England maintained a grip on the levers of the economy, monetary policy was "less effective in the current scenario".

"The MPC [monetary policy committee] has an important tool in the face of the slowdown and I think most people expect it to cut rates quite soon," he said. "But they may not be as effective without the complement of fiscal policy. The point is that because our Government failed to use times of growth to its advantage, in a slowdown we have less flexibility than, say, America."

Last week, Sir John Gieve, a deputy governor at the Bank of England, said that a sharp rise in inflation may jeopardise interest rate cuts. "We have seen big rises in the world prices of oil and food," he said. "That is being amplified in the UK by a fall in sterling and is now coming through in our food, petrol, gas and electricity prices. These are likely to raise our inflation rate well above target in the coming months."