Green Budget: Economic forecast - Bullish growth forecast heightens rat e fears

The Chancellor illustrated his call for pay restraint yesterday by unexpectedly forecasting different growth rates for the economy next year. He said if salaries were bid up as they had been in the past, gross domestic product might grow by 2.25 per cent next year. With "wage responsibility", however, that growth rate might rise to 2.75 per cent.

Economists expressed surprise at Mr Brown's bullish assessment of growth prospects for the economy next year and the rise in inflation he expects to flow from that prolonged buoyancy. They feared that the Treasury's higher GDP projection and his belief that underlying inflation would rise to perhaps 3 per cent would provide ammunition for the hawks who wanted to raise interest rates further from their current 7 per cent.

The economic slowdown which many economists expect next year will be deferred until 1999, according to the official estimates, especially if the Chancellor is right in his assumption that labour market reforms succeed in raising the growth rate trend significantly.

Mr Brown's GDP growth range for next year surprised analysts, who had expected a hint that the Asian crisis might put downward pressure on economic growth. They were surprised that the Chancellor said the risks were, if anything, on the upside. The Treasury view compared with the consensus of independent forecasts this month of 2.4 per cent and the Bank of England's implied growth forecast of around 2 per cent.

There was also surprise at the Treasury's estimate of the Government's borrowing requirements for both this year and next. Forecasts of a pounds 12bn PSBR this year, excluding the benefit of the windfall tax, and a pounds 6bn requirement next time, were higher than most predictions and represented an upward revision from the forecasts made at the time of the July Budget.

David Coleman, UK economist at CIBC said: "The market was always was going to judge it on new PSBR projections and the outlook for GDP growth. In both aspects the markets will be a little disappointed. This does put pressure back on the Bank of England to raise rates. The deficit is not falling as much as we would have liked."

Glenn Davies, chief economist at Credit Lyonnais, agreed with his colleagues' downbeat assessment, but saw a hidden political agenda at work: "From a market perspective, the PSBR revision downwards was not quite as big as one would have imagined, looking at the data. It's perhaps a little bit disappointing but may partly be a political gambit. They are trying to control public spending and obviously if the PSBR was to be revised down very sharply it makes it more difficult for him when he's arguing with expenditure departments to keep spending down."

On inflation, Ciaran Barr, UK economist at Deutsche Morgan Grenfell, was surprised that the Chancellor increased his estimate for growth in the retail price index from last July's 2.75 per cent to 3 per cent. He said: "Admittedly he's got it falling back to 2.5 per cent in 1999 and 2000 but even so it does put a little bit of a question mark on the outlook for inflation next year. It certainly differs from what the Bank of England has in its inflation target."

Andrew Snowball, European economist at Julius Baer Investments, saw a tacit message to the now-independent Bank of England in the inflation forecast: "I was a little bit surprised for the forecast for inflation ... above the 2.5 per cent target for the fourth quarter of next year. You could read some kind of message from the Chancellor to the Bank of England not to ease up where interest rates are concerned. The growth forecast was perhaps a little stronger than I expected. They are obviously fairly upbeat on the economy."