Outlook: He didn't raise taxes, but business found little else to cheer

Mervyn King; Abbey National

So that's a relief. Reports that the Chancellor, stung by the depth of the economic slowdown, has given up on his once favourite catch phrase – no return to boom and bust – and his favourite word – prudence – have proved premature. He again used them in his pre-Budget report statement yesterday.

Only this time they were cited in a rather different way. Whereas in the past prudence generally meant keeping the lid on public spending and borrowing less, today it would be "neither competent nor prudent" to cut spending and borrowing. Likewise, to cut spending now would be to risk a return to the bad old days of "boom and bust".

Gordon Brown's point is that he has earned the right to spend more so as to support the economy in its time of need and underpin the programme of public service improvement. Do the numbers support his case? Only if you believe that the present fall off in tax revenues is a cyclical downturn that will go away once the economy revives.

Personally, I think the Chancellor is also being too optimistic about the economy. I very much doubt that the economy will grow by 2.5 per cent to 3 per cent next year, still less by 3 to 3.5 per cent the year after. I can well believe that consumption growth will slow to a trickle, but that manufacturing output and business investment will pick up in the way the Chancellor forecasts seems much more doubtful. Business leaders can't see it as things stand, and it is they who in the end make the decisions.

This may be too gloomy a view, but even if it is, tax revenues will struggle to return to the sort of levels they achieved at the height of the boom, whatever the level of economic growth. Corporate profits remain exceptionally depressed, particularly in the financial sector, and as for the City, there is no chance whatsoever of revisiting the bubble conditions of a few years back. That was a once in a generation event, as were the tax revenues it generated. The Chancellor assumes only very modest growth in equity prices from this level, but he does anticipate a return to former levels of profitability and activity in the City. And pigs might fly.

As it is, the Government's borrowing forecasts for this year and next are not just higher than before, but higher than the unofficial guidance the Treasury was giving only last week. The net borrowing requirement for this year is now £20bn, against a forecast £11bn only last April. For next year the number has grown by a similar order of magnitude to £24bn.

Mr Brown is right to point out that the figures are a good deal better than elsewhere in the world, but as I've pointed out before, the problem with relying on public spending to deliver wider economic growth is that the public sector doesn't deliver any tax revenue. There was precious little in the Chancellor's statement to help the wealth generating part of the economy, business, which continues to labour under a rising burden of tax, red tape and oppressive employment regulation. Mr Brown may or may not be able to afford his increased public spending, but business certainly can't, and ultimately, it is business that pays the bills.

Mervyn King

Mervyn King has always been the bookies' favourite to succeed Sir Edward George as Governor of the Bank of England, but his odds were lengthening and the cognoscenti were saying the job would go instead to Sir Howard Davies or Andrew Crockett.

In the end, the Chancellor has opted for continuity, consistency and safety first. Few would argue with the merits of the appointment. It is also the politically astute choice, given that the City is beginning to doubt the Chancellor's will or ability to keep the public finances on the rails.

As everyone knows, Mr King is a hawk on interest rates. Indeed he has consistently been the most hawkish of all on the Monetary Policy Committee, always voting with the minority or majority for a rise in rates and nearly always with the minority and majority in resisting calls for a rate cut.

That stance was perhaps justified in the early days of the MPC, when the Bank needed to be overly hawkish to win credibility and finally stamp out Britain's inflationary past. In the last two years, it has been a lot more questionable. Mr King has been regularly accused of exerting an unnecessarily hawkish influence on rates, and in so doing of holding back growth.

But the case can as easily be argued the other way round. Mr King has twice in the last month put the now extreme imbalance in the UK economy - between the overheated housing market and buoyant consumer demand on the one hand, and on the other exceptionally poor external demand and rock bottom business confidence - right at the top of the policy agenda.

All the latest statistics confirm his analysis - plunging business investment alongside rampant consumer demand, fuelled by a combination of equity withdrawal and exceptionally high levels of household debt. Mr King is right to believe this mismatch both dangerous and unsustainable. He is also right to think that keeping interest rates a bit higher than they might otherwise be could save us a nasty demand shock later.

Mr Brown doesn't comment directly on the MPC's policy stance, but it is a reasonable assumption that he largely shares these views. Some will no doubt read all kinds of meaning into the fact that Mr King may also share the Chancellor's faintly eurosceptic bias. The five tests will dictate the policy, repeats the Chancellor, but unless the euro undergoes a sudden death bed revival, I think we know which way they will swing.

Mr King will have to relearn his craft to some extent. Sir Edward George has always voted with the majority, and his approach to policy has been consensus driven. It has worked well, and Mr King cannot afford to be as constantly out on a limb as he is now. The big concern must be that once in the high chair, he will lead the MPC into too tight an approach to rates. That's a risk the Chancellor seems prepared to take.

Abbey National

Abbey National is another lesson, if any more were needed, on why it pays to stick to your knitting. Abbey was the first building society to demutualise, and for a while its fortunes soared along with the share price.

In accordance with its pioneering credentials, Abbey then became one of the first to get into life assurance, by acquiring Scottish Mutual, and then the first to start diversifying away from the core mortgage bank into wholesale lending. Both initiatives have turned out to be utterly disastrous, so much so that the new broom at Abbey, Luqman Arnold, has decided that he needs to sweep wholesale out of the door altogether.

While Abbey was out lending to Enron, Marconi and others it knew nothing about, it naturally lost sight of the goose that laid the golden egg, the branch-based mortgage and savings business. As more and more capital was devoted to wholesale, there was less and less to put behind mortgages, and in recent years, market share has been slipping precipitously. Mr Arnold is determined to reverse the slide, and indeed return Abbey more generally to its former glories as a straight up and down personal finance supermarket.

You cannot do that without a life assurance business Mr Arnold says, so for the third time in a year, Abbey is being forced to pump more capital into Scottish Mutual. The business will also cost Abbey dear in terms of write-offs. A change in accounting methods so that the embedded value in the life fund is calculated by using the actual level of the FTSE 100, rather than the smoothed value, ensures that Abbey National as a whole is halfway there to wiping out all its pre-tax profits for this year. The other half are wiped out by wholesale banking, where provisions and related charges are rising by the day. Needless to say, the dividend is dog meat.

Shareholders can only thank their lucky stars the damage isn't worse.

jeremy.warner@independent.co.uk