Bill Jamieson: A last-chance Budget for Osborne

The Chancellor has yet to deliver steps to economic recovery, but he cannot delay much longer, writes Bill Jamieson

Cheer up! Sir Mervyn King, the outgoing Bank of England Governor, declared at the Bank’s quarterly inflation report yesterday that “recovery is in sight”. The UK economy, he added, has “cause for optimism”.

For good measure, the business lobby group the CBI – never known for bright-eyed optimism in its pronouncements – also forecast that the UK will avoid falling back into recession and that the economy will grow by 0.3 per cent in the first quarter of this year.

What could possibly go wrong?

There are three big problems with all of this. The first is that there is a huge difference between avoiding a “triple-dip” recession and economic recovery in the conventional sense. The CBI now forecasts growth of 1 per cent this year – that’s down from the 1.4 per cent it forecast previously. It is also less than half the UK’s long-term trend growth rate and is unlikely to feel like a recovery at all. Moreover, the signs of pick-up are by no means evenly spread across the UK, and the divide between the south-east of England and the rest of the UK is not narrowing, as the government pledged it would.

Second, a recovery to fractional growth is unlikely to do much for the government’s opinion poll ratings as Chancellor George Osborne continues with the austerity programme. The Sun/YouGov poll published yesterday echoes the Guardian/ICM reading, which gave Labour 42 per cent of the vote – with the Conservatives on just 29 per cent – an 11 percentage-point lead and the biggest since the “Blair bounce” in 2003.

With the cost of living again set to be one of the key battles of the next election, voters need a clear and realistic sense of better times ahead. But service spending cuts to come will be twice as deep as those made already. And a further 600,000 or more public sector job cuts are forecast. So the Chancellor has a massive task ahead in the Budget next month to set the UK on a bold and unambiguous recovery course. Growth of 1 per cent will not cut it for the country or his party.

There may also be implications for Scotland’s independence referendum next year if there is no strong economic uplift on the way by then. This will make the task of the Better Together campaign all the harder and encourage younger Scots in particular to vote for a clean and decisive break.

The third problem is inflation. For alongside his upbeat statements on the economy yesterday came a warning from the Bank Governor that he now expects the inflation rate, currently 2.7 per cent, to rise to at least 3 per cent by the summer and to remain above the Bank’s 2 per cent target for two years.

Long before the appointment of Mark Carney, the Canadian central bank governor, as King’s successor, it was clear the inflation target has effectively been mothballed as the economy wrestled with the worst financial crisis in its history. It is not just that the target has been missed on a few rogue occasions. It is now routinely missed with what appears to be the blessing of the Bank and the government.

This week we learnt that the Consumer Price Index for January continued to run substantially above the 2 per cent target for the 38th month in a row. It is widely held that the Bank’s monetary policy committee has acted with benign but realistic compassion in allowing inflation to overshoot and keeping interest rates at their ultra-low level of 0.5 per cent. Has not this 2 per cent inflation target become an outmoded fetish, blind to the realities of a struggling economy?

But, as economist Stephen Lewis of Monument Securities points out, if over this 38-month period the inflation target had been met, prices in January would now be some five percentage points lower than they actually are and would almost certainly have delivered a recovery in demand by now.

What a boon this would have been for millions of lower-income households struggling to make ends meet with average earnings that have consistently lagged the inflation rate. There is nothing compassionate or benign about an inflation rate that not only erodes spending power but also reduces the real value of savings. Indeed, an inflation rate of 3 per cent a year and more has the effect of halving the value of savings over a working lifetime.

The worry about a shift to targeting nominal (ie before inflation) GDP growth is that those who are currently financing the government’s colossal debt binge – pension funds and overseas investors in the main – will question the commitment to holding down inflation.

Holders of debt need to be assured that they will not be taken for granted and the real value of the debt inflated way. And we sure need people to buy and hold our debt. They may not have an official seat on the MPC but they are without doubt the biggest presence in the room.

A halt to quantitative easing money-printing with its inherent inflation risk is now due. But that adds yet further pressure on the Chancellor next month to deliver a Budget that will take the economic recovery steps which he has so far lacked the will or courage to undertake. Given where we are on the electoral cycle, this is his last chance.

Further backing for capital spending would help, and as the CBI director-general John Cridland tartly observed yesterday, this has to be more than accelerated pothole-filling.

But such spending on its own is no panacea, and a broader boost to enterprise is needed. A cut in VAT for home improvements is an obvious growth measure, encouraging the building industry while triggering further spending on household furniture and fittings. He could accelerate the pace of cuts in corporation tax, bringing the target rate down from 21 per cent to 15 per cent or even lower. At the same time, a reduction in capital gains tax would greatly enable equity capital to switch to new, younger companies in need of finance from sources other than the banks.

Take firm action on giveaways for better-off pensioners, lift or scrap the target for spending on overseas development and remove the ring-fence from around the budget of the NHS, which does not deserve its current cosseted status.

Some of the savings in these areas should be put towards a national insurance holiday for small firms taking on staff.

It is still not too late for the Chancellor to be bold, but the cost of delay keeps going up – and further delay now may prove fatal. Failure to act on 20 March would almost certainly condemn us to a “recovery” we may barely notice – and consign the government’s electoral hopes to oblivion.