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Monday December 5, 2005 - 11:12:52 GMT
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Economics Weekly: UK Pre-Budget Report 2005 – what can be expected?

Latest official view on the economy
The UK Chancellor will this week deliver his end of year Pre-Budget Report (PBR) to Parliament. As ever, it will be eagerly awaited by the financial markets. In the period since taking office in 1997, the Chancellor has generally been more accurate in his forecasts of the UK economy and the pubic finances than independent forecasters. This year, he has been more inaccurate than the average of external projections made a year ago and will have to admit that in the PBR due on Monday. This week’s briefing looks at the major announcements we can expect to see in the report.

UK economy growing more slowly than
expected…

Expect the economic forecast to be revised down for 2005. It is clear, see chart A, that the Chancellor will not meet the Treasury projection of 3% to 3.5% annual economic growth for 2005. It will probably be cut to 2%, still some 0.2% higher than the independent view. It is not the Chancellor’s habit to simply revise his forecasts to match that of the consensus view and he will hope that by the time he has to report on this again in 2006 data revisions are likely to show that growth in 2005 was closer to his revised figures than those of the consensus. But his economic growth forecast made in April will still have been substantially lowered. That has big implications for government borrowing.

…so the public finances are worse than
expected

Slower growth in the UK economy means that tax revenues are coming in lower than expected at a time that spending is running roughly in line with official projections. (Although spending is currently below Treasury projections, there is usually a rush by departments before the fiscal year end to use up their spending allocations.) The reason for the undershoot is due particularly to much weaker tax revenues stemming from slower growth in consumer spending, down from 3.7% growth in 2004 to just 1.8% or so in 2005. The Chancellor is likely to blame higher oil prices and a big revision to UK economic data by the Office for National Statistics (ONS), which took ½% off growth in 2005. As chart B shows, however, the public finances have been deteriorating sharply over the last five years, and whilst not currently at a crisis point, are much more precarious than they were. This is why the risks of a tax rise to put the public finances on to a sounder basis are unlikely to go away, almost no matter what the Chancellor says in the PBR on Monday. By moving the starting point of the current economic cycle, however, and by postponing some big spending programmes until 2007, the Chancellor does not have to raise taxes in 2006. As a result, the PBR may not concede the higher borrowing implied by the independent’s forecast of public borrowing shown in chart B. But the Chancellor may still have to concede that there will be more borrowing than was envisaged min the April 2005 Budget. However, partly due to high oil prices boosting North Sea oil companies profits, tax revenues have not collapsed and so the Chancellor may only announce a modest, say £2bn, rise in net borrowing compared with the last Budget.

Other announcements could also be important
There will, of course, also be other matters addressed by the Chancellor in the PBR. With high oil prices and possibly a harsh winter looming, the Chancellor may once again put off any rise in petrol and diesel duties. But to help raise revenue, there is likely to be more announcements on measures to stop tax avoidance. Other issues are likely to include a Treasury perspective on the recent pension reform proposals by Turner, progress on the public efficiency drive (Gerhson’s review), a response to Kate Barker’s housing review, more on unclaimed assets in banks (dormant accounts) and further details about Property Investment Trusts. There may also be further news on the Chancellor's efforts to encourage innovation, by using R&D tax credits and by spending more on skills training.

UK economic indicators
This week, market attention will be on the Pre- Budget Report, on the MPC meeting ending on Thursday and on economic data mainly relating to company activity. The PMI for services shows that the sector has been the mainstay of the economy in the past few years, in contrast to the hesitant nature of the recovery in manufacturing. Figures for the services PMI in November, due on Monday, are likely to confirm that this remains the case. Manufacturing data, on Tuesday, may show a slight uptick, with industrial production benefiting from the end of maintenance in the North Sea. After the November Inflation Report’s neutral stance, interest rates are expected to be kept at 4.5% when the 2 day MPC meeting ends on Thursday.

Trevor Williams, Chief Economist
trevor.williams@lloydstsb.co.uk
www.lloydstsbfinancialmarkets.com
Lloyds TSB Bank,
Financial Markets
Division,
Faryners House,
25 Monument,
London EC3R 8BQ
Switchboard:
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