Why the Chancellor is still smiling as the chill wind of recession blows through the high street

When the Chancellor of the Exchequer, Gordon Brown, stands up at 12.30pm today to deliver his Budget it will be against the worst economic backdrop since Labour took power in 1997.

Year after year the "Iron" Chancellor was able to hail another success in which the size of the surplus in the public finances had exceeded even his own much-trumpeted forecasts. A benign economy, the highest number of people in work (and paying taxes) since records began and the one-off £20bn windfall from the sale of licences for the next generation of mobile phones meant the Treasury's coffers were overflowing.

Now the iron has turned to rust. The chill wind of a global economic recession is blowing through the high streets, office floors and residential estates of Britain.

The economy last year grew by 1.8 per cent, its slowest rate since 1992. There are mounting fears of a crash in the housing market, which would empty the high street as households battened down the hatches. Shoppers have deserted the popular stores at the fastest rate for a decade, and confidence among average Britons has fallen to its lowest level for seven years. On top of this comes the impact of the hike in national insurance contributions, announced a year ago but only this month appearing in payslips. Businesses are making less money than at any time since 1992, while those listed on the stock market have seen their value – and therefore their ability to raise new money – halved. The Bank of England is expected to cut interest rates either this week or next month to their lowest level since 1955 – hardly a vote of confidence.

Against that background it may seem odd that Mr Brown will be able to forecast growth in the economy both this year and next, albeit at a much slower pace than he announced with a fanfare a year ago. But economists in the City broadly agree that while growth may be weak, there will not be a recession either this year or in 2004.

So what will save Mr Brown's blushes? The first factor is one fully within his control – public spending. Last year government spending rose by about 4.5 per cent, the fastest rate since 1975 and twice the rate of economic growth. This year it is likely to increase by more than 6 per cent, boosted by spending on the Iraq conflict.

Employment figures show that while a million jobs have been created since 1999 more than half are accounted for by the public sector, even though only one in four of us works for the state. "The UK remains close to full employment, with the public sector mopping up job losses in areas such as manufacturing," said Geoffrey Dicks, chief UK economist at Royal Bank of Scotland. If people are in work, they still spend, whoever the employer.

The final element, a surprising one perhaps, is the housing market. Despite gloomy talk, both the Halifax and Nationwide, two of the largest mortgage lenders, believe house prices are rising at well over 20 per cent a year. Although they expect some slowdown to about 10 per cent, neither is forecasting a price crash other than in highly localised areas. Homeowners borrowed record amounts of money against the value of their properties in the final months of last year.

Alex Bannister, Nationwide's chief economist, believes this has continued even in the lead-up to the Gulf conflict. "Given low interest rates and the high cost of moving many people are choosing to borrow money to improve their home rather than move," he said. "In terms of the effect on the economy it means people are spending the money, employing builders and so on."

How industry is coping

Property

The latest house price figures have shown the largest falls since 1995, yet the industry insists that the market remains steady. Fewer properties have been coming on to the market since January and the war has apparently led buyers to become more cautious.

Entertainment

British cinemagoers appear to have few economic concerns. Some 176 million people – a 30-year high – went to the movies in 2002, and the figure is expected to top 200 million by 2005. Business has been quiet for the past couple of weeks, though this may have been due to the warm weather.

Retail

Several recent studies have reported a significant slump in retailing. The Confederation of British Industry says the trading position is the worst for more than 10 years. FootFall, a company that analyses the total number of shoppers, says there has been a 2 to 4 per cent drop so far this year.