and DIANE COYLE
An increase in public borrowing has reduced the Chancellor's room for manoeuvre for tax cuts in his November Budget and threatens to upset the Government's strategy for winning the next general election.
The rise in borrowing, caused by a fall in receipts from taxes, has raised doubts that Kenneth Clarke will be able to meet his target for public borrowing of pounds 23bn and puts at risk his credibility over tax cuts this year.
The fall in growth has removed any short-term threat of a rise in interest rates. This was underpinned by the Governor of the Bank of England, Eddie George, who last night told businessmen in Manchester that he had stopped urging the Chancellor to raise base rates.
Gordon Brown, the shadow Chancellor, said tax cuts would be a "gimmick" unless they were soundly based, while Paddy Ashdown, the Liberal Democrat leader, said the figures showed that any tax cuts this year would be "irresponsible" and his party would vote against them.
Mr George's acknowledgement that interest rates should not rise marked a victory for Mr Clarke over the Governor, but the Chancellor faces a fresh threat of industrial unrest over a renewed clampdown on public sector pay.
The Chancellor angered the public sector unions after he told five pay review bodies, covering 5 million people, including nurses, doctors, teachers, the armed forces, senior military officers, top civil servants and judges, that pay rises would have to be paid for out of efficiency savings.
"The Government's approach to public sector pay continues to be that pay and price increases should be offset, or more than offset, by efficiencies and other economies," Mr Clarke said.
Teachers' leaders warned of bigger class sizes or more cuts in teachers' numbers, and Alan Jinkinson, of Unison, the biggest public sector union, said the anger could translate into militancy by union members, who are faced with a third year of pay cuts in real terms.
Economists in the City said there was little room for tax cuts. ``The Chancellor's freedom is heavily constrained,'' Bill Martin, chief economist at investment bank UBS, said.
Mr George said: ``The case for an immediate rise in rates has become progressively less pressing.'' He said the economy was weaker than he had expected earlier in the year.
However, the Governor warned: ``We still think the chances are against achieving the inflation target over the next 18 months or so without some further rise.''
The borrowing figures make more urgent the need for cuts in public expenditure. The Government is borrowing about pounds 1bn a month too much to meet its target for the full financial year. The public sector was in the red by pounds 16.7bn in the five months from April to August, more than during the same period last year. This makes it likely that the Government will miss its full- year borrowing target of pounds 23.6bn.
The Tory party conference agenda to be published tomorrow will show growing grassroots demands for tax cuts targeted at home-buyers and women who opt to stay at home to look after their children.
William Waldegrave, the Chief Secretary to the Treasury, said: "The Chancellor cannot guarantee large tax cuts for anybody. We are looking at the overall balance of the economy and it is clear we have to keep bearing down on the overall level of public spending, which includes pay."
Mr Waldegrave has called on Cabinet ministers to volunteer cuts of 5 per cent in the spending totals agreed in the last Budget for the next financial year.
The Prime Minister's office denied the spending cuts would deepen the recession, although some observers believe the strategy of reducing public spending to below 40 per cent of GDP is too tight.