View from City Road: Hint for the Chancellor

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If the Chancellor would like some ammunition for his next encounter on interest rates with Eddie George tomorrow, perhaps he should scrutinise the graph. Prepared by Gerald Holtham, of Lehman Brothers, it puts succinctly the case for believing that this year's tax increases are going to slow the economy.

Everyone agrees that real incomes are going to be hard hit by the increases next month. But the average of the economic forecasters nevertheless expects consumers' spending to grow by 2 per cent or more because people will save less of their income and spend more. But will they?

True, the savings ratio fell to just 6 per cent of income during the Lawson boom. But savings are computed net of borrowing - the fall in the savings rate was due to the enormous increase in mortgages. Debt as a share of disposable income doubled during the Eighties, and it is unimaginable to suppose that this could occur again.

If anything, consumers will be more cautious because their debts are high. This is also why the Bank of England and others are probably wrong to argue that the delayed effects of the past interest rate cuts will still feed through. People have already enjoyed the bonus on their incomes and are unlikely to build up their debts.

Mr Holtham argues that the savings ratio is unlikely to fall below 9 per cent, its low point in upturns before the 1981-90 expansion. At the end of 1993 the savings ratio was about 10.5 per cent. So consumers' spending growth might be little more than 1 per cent through this year. Time for another interest rate cut?

(Graph omitted)