Warning on tax cuts as steady growth continues

Economy: Fresh evidence of buoyant recovery as ministers meet, but the Bank of England pleads for vigilance on inflation

There was fresh evidence of a buoyant economic recovery yesterday, on the eve of the Chancellor's key pre-Budget meeting today with ministers and officials at Dorneywood.

The British Chambers of Commerce (BCC) called on the Chancellor to leave taxes and interest rates alone, following signs of higher demand for both manufacturing and service industries in its latest quarterly survey. "The economy continues to grow at a steady rate and the manufacturing sector is returning to levels of confidence last seen 18 months ago," said Ian Peters, deputy director general.

The annual meeting at the Chancellor's official country residence in Buckinghamshire, overlooking the autumnal splendour of Burnham Beeches, will set the broad shape of the Budget tax and spending strategy. Mr Clarke will be joined today by senior officials from the Inland Revenue and Customs and Excise as well as the Treasury.

With every indication that the spending round has been very tough, cuts of around pounds 5bn from existing spending targets are expected. These are likely to be used to finance reductions in personal taxation, despite all the signs that consumer spending is picking up sharply without any further help from the Chancellor.

The BCC survey for the third quarter of the year showed that consumer demand was driving higher sales for service sector companies, which was finally trickling down to manufacturers. Manufacturers reported a big increase in their expected employment levels, reversing the job-shedding trend. Confidence in industry returned to its 1994 peak, and in services reached the highest since 1990.

The survey also found a notable increase in investment plans in manufacturing. The rate of capacity utilisation in manufacturing has reached its highest level this decade. The BCC noted that capacity constraints were the one possible signal of inflationary danger, as there were few complaints about higher wage settlements or even skill shortages.

Both domestic and export orders were up compared to the previous quarter, suggesting that there had not yet been any adverse impact on overseas sales from the strong pound.

The latest economic evidence is likely to reinforce the Bank of England's view that there is a "significant" danger of inflation missing its target by 1998. The Bank's annual pre-Budget letter to the Chancellor this week is thought to have set out the view, expressed by the Governor Eddie George in a speech earlier this week, that fiscal policy must be as responsible as interest rate policy to keep growth and inflation on a steady course.

The size of the tax cuts announced next month will influence the Bank's view about the urgency of the need for higher base rates. Its Inflation Report, due three weeks before the Budget, will have to be based on the assumption of no change in taxes and spending.

Mr Peters of the BCC said interest rates should remain unchanged. "Further reductions could cause undue stimulus to the economy, whilst any increase could threaten the delicate balance of this recovery and hurt export markets," he said.

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