Preview of the U.K. Budget to Be Held on 24 March

Better-than-anticipated (or to put it more accurately less bad-than-feared) public finance figures for February have given Darling some "wiggle" room in the budget. The data indicate that Darling could well undershoot by around £10 billion the Public Sector Net Borrowing Requirement (PSNBR) of £178 billion that was projected in last December's Pre-Budget Report.

The markets and credit rating agencies will be looking for Darling to use any undershooting of the PSNBR to improve the public finance situation. February's smaller-than-expected shortfall does not mask the fact that the public finances are still terrible and unsustainable.

In contrast, many members of the government (very likely including a certain G. Brown) will be putting pressure on the Chancellor to use this money for some "sweeteners" in the budget.

It seems likely that Darling will do both. With the public finance data for the first 11 months of fiscal 2009/10 (March 2009-February 2010) indicating that he can legitimately assume that the PSNBR will come in some £10 billion less than the £178 billion projected, he could use £5 billion (or half of whatever figure he comes up with) to cut borrowing. If the Chancellor wanted to send some sort of symbolic message of his commitment to improve the public finances, he could even allocate more than half of the shortfall to cutting borrowing.

This would still leave Darling with perhaps up to £5 billion to spend on small targeted measures aimed at helping less-well-off households, the unemployed, and businesses. He could look to justify this by saying that the current fragility of the recovery means that the economy could still do with some help, but the fact that he has not used no more than half of the PSNBR savings shows he is striking a sensible balance between trying to safeguard the recovery and reining in the public finances.

Meanwhile, Darling has ruled out further spending cuts in the budget.

Over the longer-term, Darling is likely to broadly stick to the strategy and forecasts that he laid out in last December's Pre-Budget Report. This aims to reduce the budget deficit from a now likely 12.1% of GDP (£170 billion) in fiscal 2009/10 to 5.5% of GDP (£96 billion of GDP) in 2013/2014, and 4.4% of GDP (£82 billion) in 2014/15.

The government will likely hope to score heavily with the electorate by sticking to its message that any earlier and faster tightening of fiscal policy—as favoured by the opposition Conservative party—would risk plunging the still-fragile economy back into recession. Darling has referred to the government's plan as the most prudent approach and "non-negotiable." He has indicated though that if GDP growth comes in higher than expected going forward, then it may be possible to take extra steps to cut the budget deficit more quickly.

In actual fact though, we believe the Chancellor's growth forecasts are far too optimistic over the long term, which suggests that the budget deficit will not come down as quickly as targeted by the government without additional tightening measures. Specifically, Darling projects GDP growth at 1.0-1.5%, which looks realistic (although we admittedly suspect that growth will not exceed 1.0%). The Chancellor forecasts GDP growth to improve to 3.25-3.75% in both 2011 and 2012; although for planning purposes he projects it at 3.25% in both 2011 and 2012. He also sees growth staying at 3.25% through to fiscal 2014/15. In contrast, we expect GDP growth to be limited to 1.7% in 2011 and 2.3% in 2012, while the consensus forecast is for expansion of 2.3% in 2011.

Darling seems unlikely to give few extra details of where the spending cuts will come over the coming years, indicating that this will be decided upon in the comprehensive spending review that will take place after the general election.

The Chancellor is also unlikely to announce any further tax increases at this stage, although Lord Mandelson has warned that further tax increases may be needed in 2011,

by Howard Archer