• In his first Budget, Alistair Darling faces the tricky task of trying to rebuild Labour’s reputation for fiscal responsibility after the Northern Rock debacle and at the same time being seen to support the flagging economy. We think that he will juggle these aims by playing down the damage to the fiscal position caused by the Rock and providing a small tax giveaway to mitigate the economic slowdown.

• The Chancellor will be forced to acknowledge that the outlook for the economy has weakened since October’s Pre-Budget Report. Although he predicted that GDP growth would slow sharply this year, the weakening in global activity, the state of the domestic housing market and the growing credit crunch mean that the risks have shifted firmly to the downside. Meanwhile, the strong recovery he anticipated next year now looks much less likely.

• At the same time, though, the state of the public finances points to the need for consolidation and the Chancellor will be keen to demonstrate that the Government remains in control of the fiscal position. Although Mr Darling’s Pre-Budget Report forecast of public borrowing of around £38bn this year now looks broadly on track, this a very poor starting position when the economy looks set to slow sharply. A 1990s-style downturn could push borrowing as high as £150bn p.a.

• Meanwhile, the nationalisation of Northern Rock has compounded the strains on the public finances by adding around £100bn to public sector debt. By adapting his fiscal rules, Mr Darling will play down the impact of Northern Rock on the Government’s books. But a major housing market downturn, which would presumably reduce the value of Northern Rock’s mortgage book, would leave taxpayers exposed to significant losses.

• In short, the Chancellor is caught between a Rock and a hard place. The result is that this Budget is unlikely to set the world on fire and certainly won’t emulate the US government’s forthright action to support its beleaguered economy with a major fiscal stimulus.

• Nonetheless, January’s timely surge in corporation tax receipts has probably made room for the Chancellor to show that he is supporting the economy by announcing a small package of net tax cuts. A further cut in income tax is a possibility, as is a reduction in stamp duty to help the ailing housing market. He may also suspend the planned rise in fuel duties and place a windfall tax on utility providers.

• A small giveaway should not provoke an unfavourable response from the Monetary Policy Committee. And while it will have a detrimental effect on the public finances in the near-term, if it helps stop the economy from descending into recession, it might ultimately prevent a much bigger fiscal disaster further ahead.

Roger Bootle
Economic Adviser to Deloitte