Boom fuels demands for tax or rate rises

Britain is booming as the Conservatives claim, the latest figures for national output suggested yesterday. But the rapid growth recorded by the last official statistics due before the general election led to calls for an immediate rise in taxes or interest rates.

City economists were highly sceptical about John Major's claim yesterday that his Government had broken the cycle of boom followed by bust. "The failure to raise either taxes or interest rates is the political business cycle gone mad," said David Bloom at James Capel.

A growing number of analysts favour tax increases in a post-election Budget because an increase in base rates might drive the strong pound even higher.

The 17 per cent exchange rate rise since last autumn has tilted the balance of growth towards consumer spending and away from exports. The boom is also centred on the South-east and industries like financial services.

"For the first time in 20 years some good old-fashioned Labour policies are exactly what the economy needs. A few extra pounds on the mortgage don't stop highly paid people buying dinner at Quaglinos," said Simon Briscoe, an economist at investment bank Nikko. "If there were ever a good economic case for redistributing incomes through tax, it is now."

While business organisations have also started to demand tax increases as opposed to higher interest rates, some economists still think higher borrowing costs are needed to cool the boom.

"You can't tinker with taxes to fine tune the business cycle, and it is the easiest thing in the world to reverse an interest rate increase if exports slow too sharply," said Kevin Gardiner at Morgan Stanley.

All the experts agree that whoever is chancellor after the election will need to tighten the reins of policy swiftly.

Philip Shaw, chief economist at Union, predicted that any improvement in the Tories' standing in the polls this week would unnerve the markets. "That would make it more likely that we would get a hung parliament, with a government that could not take unpopular decisions."

Yesterday's figures for gross domestic product, the broadest measure of economic activity, showed a 1 per cent increase in the first quarter of this year. It reached a level 3 per cent higher than a year earlier. This was the fastest growth for two years.

Service sector output increased by 1.2 per cent during the quarter, and 3.9 per cent year on year. Business services, including accountancy and consultancy, continued to show the highest growth according to the Office for National Statistics (ONS). Finance, communications and catering also grew strongly.

But the ONS also indicated that industrial production grew at broadly the same rate as the previous quarter, which implies that its biggest component, manufacturing output, picked up despite the strong pound.

With earnings growing faster, tax cuts this month and building society share handouts starting, GDP growth is likely to accelerate. Sterling's impact on exports is not expected to become severe until next year.