The warning will deeply embarrass Kenneth Clarke, as he is coming under growing pressure from senior Tory backbenchers to deliver tax cuts to give the Government any hope of victory at the next election.
The Treasury's panel of independent economic forecasters urged caution at the meeting yesterday with Alan Budd, the Chancellor's chief economic adviser. Mr Budd has told associates he would consider quitting the Treasury early if there is a big tax giveaway in the Budget on 28 November.
Of the six members of the Treasury's panel at yesterday's meeting, only one is firmly in favour of lower taxes. Labour will accuse the Chancellor of preparing a Budget to rescue the Tories rather than take Britain further out of recession.
William Waldegrave, the Chief Secretary to the Treasury, will tell Tory MPs at a meeting of the backbench finance committee today that they must prepare for unpopular cuts in spending to pay for tax cuts. The Education Secretary, Gillian Shephard, is still fighting to preserve her budget, warning of more teacher redundancies.
The spending purge is so serious this year that the powerful Cabinet EDX committee, chaired by the Chancellor, is holding almost daily meetings. Mr Waldegrave has been forced to delay his meeting with the backbench MPs because of more meetings today over the refusal of Mrs Shephard and the Secretary of State for Health, Stephen Dorrell, to settle their new departmental budgets.
With just over a month before the Budget, important tax and spending decisions still have to be taken. Treasury sources said Friday's crucial pre-Budget meeting had still left key questions unresolved.
This year's Budget is being seen in the City as a stiff challenge for Mr Clarke, who has to balance the needs of the economy against the wishes of the backbench MPs who made it clear at the party conference just two weeks ago that tax cuts ought to be top of his agenda.
Miscalculation by the Chancellor could send sterling sliding, City economists said. Further turbulence in the currency markets, taking the pound dangerously near its all-time low against the German mark, highlighted the danger of taking risks with the public finances.
The financial markets have been alarmed by recent figures for government borrowing. The public sector borrowing requirement has been higher so far this year than last, despite a tougher target set in the last Budget. Any prediction in the Budget for a public sector borrowing requirement that was not both lower than this year's likely total and believable could trigger an attack on sterling.
The pound fell almost two pfennigs yesterday to DM2.1857, not far above its record closing low in May of DM2.1768. To the alarm of the Bank of England, the currency markets have treated the pound as a weak currency this year.
The economic evidence between now and the Budget is unlikely to strengthen the arguments for stimulating the economy. Yesterday's figures for GDP in the third quarter confirmed that growth has slowed as expected. It was 2.4 per cent higher than a year earlier, compared with 2.8 per cent growth in the second quarter.
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