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Brown’s upbeat pre-Budget report will not convince economists

The chancellor is sticking to his borrow to invest approach but there is growing speculation that a black hole in public finances could lead to surprise tax hikes, says Rachel Blackmore

Last week the chancellor delivered his pre-Budget report, setting out not only his assessment of the state of the economy, but the key areas the election will be fought on and perhaps his own leadership manifesto.

This was an important speech for the chancellor. Since 1997 he has been the steward of a well-performing economy, comfortably sticking within his ‘golden rule’ – that he will borrow only to invest – rather than to fund day-to-day spending. However, more recently there has been speculation that there is a black hole in public finances which may have to be filled by raising taxes. In addition, it is clear that the Bank of England’s five rate rises have had the desired effect and the housing market is finally cooling.

Brown gave an upbeat assessment of the economy, in which he restated his belief that his cherished fiscal rule will be met over this cycle and the next. The speech was littered with examples of where the UK economy is outperforming those of other developed countries. This will raise a few eyebrows in the City, where economists have been questioning the Treasury’s optimistic view of economic growth. But it is not only City economists who hold this view. Last week the Organisation for Economic Co-operation and Development, which represents 30 leading economies, gave a gloomy assessment of the UK’s growth prospects based on a cooling in the housing market and a fall in industrial production.

The OECD has suggested that three further interest rate rises will be necessary because of increasing pressures in the labour market, predicting a rise in each of the first three quarters of 2005, which would take rates to 5.5%.

However, this might be an overly pessimistic view, as current money market rates, which can give a reasonable indication of future interest rate rises, would suggest that interest rates have peaked.

In terms of substance, the BSA was watching out for news on the Miles Report, Stamp Duty, dormant accounts, ISAs and financial exclusion. We were pleasantly surprised that the government has decided to consult on a stay of execution on cash ISA limits, due to be cut from £3,000 to £1,000 in 2006.

The Miles Report was a different story. In his April 2003, Brown said that “while most mortgages elsewhere are fixed rate, most UK mortgages – 64% of new mortgages – are at short-term variable rates with most of the rest fixed for just one to five years. And with housing demand at historically high levels, housing supply has remained low”, going on to explain that “most stop-go problems that Britain has suffered in the past 50 years have been led or influenced by the highly cyclical and often volatile nature of our housing market.”

“Housing finance needs to become more certain and planning more flexible,” the chancellor told the House of Commons, “so I have asked David Miles – Professor of Finance at Imperial College – to examine the case for, and how, Britain can develop a market for long-term fixed rate mortgages – something that is important to the UK in or out of the euro, and more important in a single currency area.”

The update on progress can be found tucked away on page 68 of the report. While there are certainly elements of Miles’ recommendations being taken forward, the kind of high profile support needed for any real change in take-up of long-term fixed rate mortgages is not forthcoming.

It is difficult to lobby for too many tax breaks at once, especially when there are already question marks over the state of the nation’s finances. However, there was also nothing in the pre-Budget Report on Stamp Duty. First-time buyers are still struggling to get a foot on the housing ladder and failing to raise the tax threshold means that 76% of these are now paying a tax which was never intended to catch them. Compare this with the 30% who paid Stamp Duty in 1993.

The chancellor mentioned first-time buyers, but only in passing – “as we take forward the Barker Review and the Deputy Prime Minister publishes his five-year housing and sustainable communities strategy, we will pilot mixed communities in deprived estates and provide further support for first-time buyers”, which is laudable but light on detail.

The other big story was financial exclusion. The new financial secretary, Stephen Timms MP, says he intends to galvanise action in this area. The Treasury is putting its money where its mouth is by allocating £120m to tackle this issue, which will include more face to face money advice.


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