Brown's war chest put at £15bn

Pressure on Gordon Brown, the Chancellor, to cut taxes in the Budget to head off political discontent is set to rise today after a respected economic forecaster said the public finances were heading for a £15bn surplus.

Pressure on Gordon Brown, the Chancellor, to cut taxes in the Budget to head off political discontent is set to rise today after a respected economic forecaster said the public finances were heading for a £15bn surplus.

But the National Institute for Economic and Social Research warned that massive tax cuts would trigger higher interest rates at a time when the economy was growing strongly.

"Clearly macro-economic policy runs the risk of repeating the errors of the 1980s," it said in a reference to tax cuts that sent the economy into a spiral of boom and bust. It also issued a rosy forecast for economic growth next year but said consumer spending must to fall to offset rising government expenditure.

Seperate figures yesterday showed household consumption is already starting to slow, with a sharp drop in mortgage lending and a dip in confidence to its lowest level for two years.

The National Institute said the Budget surplus would come in £10bn higher than the Treasury forecast just seven months ago and allow Mr Brown to cut taxes "substantially".

The Chancellor, who delivers his pre-Budget report on 8 November, is being urged to find extra money for pensioners and to cut the level of duty of fuel in the wake of the recent protests.

The institute said Mr Brown could implement massive tax cuts without breaking either of the fiscal rules he set when Labour won power in 1997. But it warned: "The state of demand in the economy is such that significant tax cuts or pension increases should be expected to lead to a higher interest rate."

The National Institute believes rates are set to rise to 6.5 per cent from 6 per cent, "contrary to expectations in financial markets". It said the current robust state of the public finances, which will remain for the next six years, appeared to make more generous state pension provision "eminently affordable".

Following the outcry over this year's 75p-a-week increase, the Chancellor has made it clear he will provide an above-inflation rise for all 11 million pensioners. But the institute warned that if Mr Brown gave into a trade union campaign for the restoration of the link between pensions and earnings, broken 20 years ago, it would mean a 5p hike in the basic rate of income tax.

The Chancellor this week made it clear he would resist calls for extra cash "from which ever quarter they come". "We will resist calls for irresponsible and unsustainable pre-election handouts," he said.

Geoffrey Dicks, UK economist at Royal Bank of Scotland, said the Chancellor was under pressure from the Prime Minister to unlock the war chest. "There may be undesirable repercussions on interest rates and the pound but in terms of affordability, the sky is the limit," he said.

The National Institute forecast the economy would grow 3.5 per cent, following 3 per cent this year. It assumes government expenditure will grow on the back of the recent £43bn increase in Treasury spending plans but that household consumption will fall.

New mortgage approvals fell by 19 per cent in September compared with a year ago, to £3.51bn from £4.31bn, the British Bankers' Association said. Separate mortgage figures from Barclays Bank said growth in lending fell 7 per cent in September alone. Business Strategies, an economic analyst, said consumer confidence fell over the summer to its lowest level for two years as households grew more gloomy about the outlook for the economy and their own finances.

The National Institute said the threat to inflation from strong growth and record low unemployment would be offset by higher productivity, which is forecast to grow 2.5 per cent next year - the best for seven years.