OECD calls for a tough July Budget

The Government was yesterday urged to introduce a tough Budget by the influential Organisation for Economic Co-Operation and Development (OECD). It said government borrowing was still too high after six years of economic recovery, even though it had been improving.

In an unusually hard-hitting mid-year report on its member economies, the think-tank also said European monetary union should not be delayed simply because some countries would just miss the 3 per cent of GDP ceiling on government borrowing. It predicted Germany, France and Italy would exceed the limit, while the UK, Spain and Portugal would creep within it.

The OECD also warned about buoyancy in stock markets. "Current [share] prices are very high and may not be fully justified by underlying conditions," the report said. A sharp correction could damage the weaker economic recoveries in continental Europe and Japan.

The organisation, which has lavished praise on the UK economy in recent reports, said jobs market reform was an urgent priority in France and Germany. It is forecasting a sharp fall in UK unemployment but rising jobless rates in the big continental countries.

The OECD said economic prospects for its members generally were the best for a decade. For Britain it foresees strong growth and a favourable inflation outlook.

The unemployment rate will fall to 5.5 per cent by the end of 1998, it predicted, in effect full employment. Headline inflation would fall until the middle of this year before climbing.

But the report said it would be better to "rebalance" policy by relying on higher taxes rather than higher interest rates to restrain the economy. "Fiscal consolidation has progressed more slowly than originally planned over the past two years," it said.

On the basis of the tax increases announced in last November's Budget, interest rates would have to rise again this year, the OECD said.

But even on existing plans, the UK will be one of the few EU countries to meet the single currency target of a deficit-to-GDP ratio below 3 per cent this year. Spain is the only other big economy likely to meet this.

Although its economists have revised down the expected deficit ratios in France and Germany, it still sees them just missing the ceiling. It warned against the probable calls for a delay to the single currency.

"Whatever happens to the recovery during the next six months, fiscal policy should not focus excessively on the outcome for 1997," the report said. It argued that the reason key countries will miss the target is the slowness of their business cycle recovery, whereas the decision should focus on medium-term progress.

However, the report urged the French, German and Italian governments to take much more decisive action on jobs market deregulation.

"The political constraints which have prevented the introduction of broader reform programmes need to be overcome if progress is to be made on durably reducing unemployment and raising employment," it said.

It added that Italy would need to undertake wide-ranging pensions and welfare reform if it wanted to prevent the government budget deficit widening again in 1998.

The rosiest outlook contained in yesterday's report was the forecast for the US. The OECD has revised up its forecast for US growth to 3.6 per cent this year and puts unemployment at 5 per cent. However, it foresees little danger of inflation and only a modest increase in interest rates.