Pre-Budget statement: Inflation outlook raises the prospect of more rate cuts

Forecasts

THE CHANCELLOR yesterday predicted inflation would fall below target next year, a move seen as signalling the Government's desire for further cuts in UK interest rates.

The Treasury has also substantially cut its forecasts for economic growth in 1999, although the predictions are still more optimistic than those of many leading City analysts.

Because of the marked downturn in the world economy, the Treasury predicts the UK economy will grow by between 1 and 1.5 per cent next year - 0.75 percentage points lower than forecast at the last Budget. The forecast assumes significant cuts in interest rates by the Bank of England.

Gordon Brown said: "The global downturn has forced every country, every continent, every financial institution to cut their estimates for growth." And he admitted that further shocks to the world economy could force another cut in his UK growth forecasts.

The pre-Budget report reads: "There are risks that the UK slowdown could be sharper than forecast if the world outlook deteriorates further. But the consensus of independent forecasts, with which the Treasury agrees, is that the cyclical downturn will be less pronounced than in the past."

City economists interpreted these remarks as a "get out clause". One leading figure remarked: "He is just setting the ground for further cuts in his forecasts in March."

Doug McWilliams, chief executive of the Centre for Economics and Business Research, said: "We do think they [the forecasts] are very much on the optimistic side. The Chancellor is assuming three things. First, that the domestic economy is in strong shape. Second, that the world economy bounces back. And third, that going into the euro won't constrain economic policy."

Dharshini David, from HSBC Securities, agreed the growth forecasts were optimistic. "The Chancellor is predicting an incredibly soft landing for the economy", she said.

The consensus City forecast is that the economy will grow by 1 per cent next year, the same as the Treasury's "worst case" prediction.

Many City experts also said government predictions for growth in 2000 and beyond were optimistic, and criticised the forecasts for ignoring the impact of the millennium bug.

The Treasury said: "Whilst a potentially significant impact [of 2000 problem] cannot be ruled out... any single estimate would fail to reflect the very large degree of uncertainty surrounding the issue."

The pre-Budget report reads: "The Government's forward-looking, long- term policy framework is designed to lay the foundation for a sustainable recovery."

According to the Chancellor's pre-Budget report, GDP will grow by between 2.25 per cent and 2.75 per cent in 2000, and between 2.75 per cent and 3.25 per cent in 2001.

Paul Mortimer-Lee, at Paribas, said: "He's got the setback as pretty short-lived. He is a bit optimistic about growth in 2000." Eric Fishwick, at Nikkio Europe, said the predictions for the recovery were "questionable".

The Chancellor predicted that RPIX - the underlying rate of inflation that is targeted by the Bank - would dip below 2.5 per cent early next year. "The slowdown in growth will, in turn, dampen inflationary pressures," he said. "RPIX inflation is forecast to return to its target level of 2.5 per cent by the end of 1999, after temporarily dipping below it earlier in the year."

The predictions were seen by many in the City as a signal that the Government would like to see substantial cuts in rates by the Bank of England's Monetary Policy Committee, which begins its regular two-day meeting today. Interest rates in most European countries are less than half the level in the UK.

The Chancellor said the deteriorating world economy had hit UK trade, and that the trade deficit would be larger than predicted. "The deterioration in the trade position since the March Budget has been driven by adverse global economic developments," he said. "The impact of financial market turmoil in Asia has depressed demand for UK exports and intensified competition from Asian exporters in third markets."

For this year, Mr Brown is predicting a deficit on the current account of pounds 1.75bn, substantially less than forecast in March, partly because of recent upward revisions to official statistics. Next year, however, the UK's trade position will begin to deteriorate rapidly. The Government is predicting a current account deficit of pounds 7.5bn in 1999; pounds 8.75bn in 2000; and pounds 9.25bn in 2001. In March, the predictions were pounds 6.5bn, pounds 6.75bn, and pounds 6.5bn.

Again, City economists criticised the forecasts as overly optimistic. "The Chancellor has got a bit too much world growth. He is predicting too large a rise in exports," Mr Mortimer-Lee said.

The Treasury said upward revisions to official statistics had affected the Government's assessment of the output gap - or the difference between demand and supply. The pre-Budget report said: "Revised national accounts data show that the economy had more momentum in 1997 than previously estimated. This implies an upward revision to the estimated current output gap, reinforcing the need for a slowing of growth this year to head off inflationary pressures."

The Treasury has revised its estimate for 1997 growth to 3 per cent, 0.5 percentage points higher than estimated in March. The output gap is now estimated at around 0.5 per cent for the third quarter of 1998, compared to "just below zero implicit in the Budget forecast".