Bill Jamieson: Tax and debt will steal any election 'victory' outright

INVEST in Britain. We may not know who's going to be running the country. But our debt is long dated. The government pays on the coupon, the public pays its taxes – and we're not in the euro.

It hardly seems the right time to count our blessings. We have had a week of ticking off from the Institute for Fiscal Studies on lack of candour on the spending cuts required, warnings of big tax rises from the National Institute for Economic and Social Research – and a stock market wobbling on worries of sovereign debt downgrading across the eurozone.

This smoke and gunfire from Greece is drifting uncomfortably close. And the atmosphere is starting to grow airless, with the uneasy still of an approaching storm. What does the future hold? No one can even give a straight answer to the question: What's going to happen the Day After Tomorrow?

For now, a recovery of sorts is unfolding. Unemployment is falling. House prices are rising. And the national attention is diverted by a series of TV election debate spectaculars. Does it matter to the economy and markets if there is a hung parliament?

Warnings of a flight from sterling and rising interest rates have been dismissed as scaremongering. Political boffins point to experience elsewhere showing that of the ten biggest fiscal contractions across the OECD economies, eight occurred under coalition governments.

But such comforting assurances only work up to a point. Britain has a poor record of coalition governments. Almost all have collapsed within 18 months. Unlike continental countries, we do not have fixed-term parliaments, so coalitions are much more vulnerable to political raid and collapse.

And the public is in no mood for debt reduction. The axe, we are assured, can be spared a year. Large sections of public spending can be ring-fenced.

This lack of an air of crisis is a crucial difference between the UK and Greece. But worries on the quality of sovereign debt being issued by cash-strapped governments are growing appreciably. This prevailing sense of normality that feeds our complacency may leave us vulnerable to a nasty awakening.

A Conservative government with a slim overall majority may not command the widespread public support needed for tough spending cuts. As for the alternative, it is not the prospect of a hung parliament per se but of a prolonged period of political uncertainty that gives concern. It is quite possible the key pre-occupations will be patching up a short-term coalition and hammering out agreement on electoral reform in time for a second election in a year or 18 months. This would suggest unpopular deficit reduction being pushed down the agenda. Prospective buyers of debt would then ask when, if ever, the deficit and debt mountains would be tackled. Prolong the uncertainty and there is indeed a prospect of interest rates being moved up to guard against a further sharp fall in the pound.

The UK stock market took a tumble last week, reflecting growing investor concerns over a broadening crisis across the eurozone. Professional investors and financial advisers attending a conference in Edinburgh last week by Broadgate Mainland and Scottish Investment Operations were given a series of stark warnings. Colin McLean, managing director of SVM Asset Management, said that any intervention from the IMF and a downgrading of the UK's credit rating were "possible scenarios for the UK economy and these would bring more decisive action in reducing the public deficit than any forthcoming election outcome".

Two other considerations are set to darken any sense of "victory" on Friday morning. The NIESR warns in its report that taxes would have to rise by the equivalent of 6p on the basic income tax rate to get the budget deficit below three per cent by 2020. It sees economic growth of just one per cent this year, followed by 2.25 per cent growth in 2011 – well below the government's forecast of between 3 per cent and 3.5 per cent next year.

And last week's news of a house price recovery may not be as good as it looks. Headline figures from the Nationwide claimed a 10.6 per cent annual growth in prices in the year to April.

But according to Lombard Street Research, the three-month-on-three-month growth rate provides a better point of comparison. At 4.4 per cent in April, this rate has been falling steadily since September of last year. The monthly increase was no stronger than that in March.

Analyst Melissa Kidd concludes that the figures do not point to a return to the long upward march in house prices experienced in the 12 years to 2007 and that the rebound has been driven by very low stock levels.

The perverse upside to this conclusion, together with the downbeat NIESR forecast, is that interest rates will stay at 0.5 per cent well into next year. But that presupposes that sterling and the bond market do not suffer a bout of investor nerves this summer. Given all the uncertainties over The Day After Tomorrow, all bets are off.