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What Merrill Lynch thinks Gordon will say on Monday

The UK chancellor will present his Pre-Budget Report on Monday December 5 at 15.30.

Merrill Lynch says it is expecting a mildly contradictory to neutral package along with higher borrowing numbers and lower gross domestic product forecasts.

UK fiscal policy has been highly expansionary in recent years, resulting in a move from large budget surpluses in the late 1990s to large deficits today. The government seems likely to embark on a prolonged period of fiscal tightening through this parliament. But against a backdrop of subdued economic activity Monday’s PBR is likely to be only slightly contradictory or, quite possibly, fiscally neutral. Net tax increases/expenditure cuts in excess of 2.0bn look unlikely. It is, however, sobering to consider that Gordon Brown has unveiled three major tax-raising Budgets in the last eight years – each of them within 12 months of a Labour general election victory.

According to Merrill Lynch this is likely to be the seventh PBR or Budget in succession in which the chancellor has raised his borrowing numbers. In the first six months of 2005-06 spending has undershot the treasury’s forecasts but revenues have also fallen short (rising by 7.2% compared to a treasury forecast of 8.5%). Weakness reflects shortfalls in VAT and Corporation Tax receipts. Personal tax payments have been strong because of the chancellor’s decision not to uprate thresholds in line with incomes and asset prices. The governor of the Bank of England has suggested that this “fiscal drag” helps explain the weakness of UK consumption this year.

Merrill Lynch expects the chancellor to raise his forecast for the key measure of the deficit, public sector net borrowing, from 31.9bn to 35.0bn in 2005-06 and from 29.0bn to 34.0bn in 2006-07. It expects the actual outcomes to be even higher than the upwardly revised forecasts at 38.0bn and 39.0bn respectively.

The chancellor will almost certainly predict he will meet his key fiscal rule: the golden rule that requires borrowing over the cycle is made only for investment purposes. Meeting the rule has been helped by pushing back the start date for the economic cycle over which the target is assessed, from 1999-00 to 1997-98. The end date is likely to be 2005-06.

Finally, Merrill Lynch says it expects the chancellor to cut his 2005 growth forecasts sharply, from 3.3% to about 2.0%, with the 2006 forecast falling slightly from 2.8% to about 2.5%.


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