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Monday March 26, 2007 - 14:44:05 GMT
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Forex Market News- Economics Weekly: A Budget of tax and spend - Is this a 2008 election Budget? Weekly economic data preview Final UK Q4 gdp and US inflation data top the release calendar

Economics Weekly:
A Budget of tax and spend - Is this a 2008 election Budget?

A Budget full of sound and fury but little net impact on the economy
This might have been called an ‘election' Budget – had we not known that the next one is not due until 2009 - if only because of the 2p cut in the basic rate of income tax and the same off large company corporation tax. These cuts are, however, due to be implemented next year, in fiscal year 2008/9. Tax cuts of this nature are not usually made unless an election is about to be called. But Tony Blair is likely to resign this summer and Brown, the Chancellor in his 10th year and 11th, and possibly last Budget, is likely to be elected unopposed as Prime Minister. This is especially so after what was a bravura performance and, therefore, in this sense it was an election budget.

However, there is also a case for saying that a general election is likely to be called sometime next year or early 2009, when these tax changes will actually take effect. So this Budget sets the battleground for that as well. Can the opposition cut taxes should they win the next general election or cut spending? Of course, by then Mr Brown is not likely to be Chancellor and hence not responsible for implementing the tax cuts. However, his successor will have little room for manoeuvre.

This was a Budget with a lot of bold announcements many that were designed to grab the headlines, and undoubtedly will. Much of it was political theatre, using much of the best of what the opposition parties had to suggest. But there was little in the way of significant change to the stance of the government’s fiscal policy, i.e. the path of current net borrowing compared with the 2006 Pre Budget Report (PBR). In fact, the overall economic impact of the Budget changes is virtually zero over the current year and in future projections, as we show overleaf, despite the dramatic nature of some of the announcements made in the speech. In other words, this was a neutral Budget though one that leaves public borrowing stretching far into the future, with borrowing of 1.6% of gdp even in 2010/11.

The clear risk is that should the UK face a shock that forces down economic growth, then government debt will rise sharply higher than shown in the projections. This is particularly the case if the 'automatic stabilisers' kick in - this is where government spending rises as unemployment rises while at the same time tax receipts decline for the same reason.
The Budget speech devoted surprisingly little time to the economic forecasts, other than to onceagain point out that UK growth has been positive for the longest period since the Second World War and better than that of comparable large economies in the last decade. Overall, however, the 2007 economic projections have been little changed compared with those announced in the 2006 PBR. In short, the economy has behaved pretty much as was projected then, which was, admittedly, within the last six months. Our own economic forecasts, which we have not altered as a result of this Budget, are very similar to the Treasury’s, though we are a little more pessimistic about inflation and therefore expect base rates to rise in the next few months, although we also expect base rates are likely to be cut in 2008 as the economy slows from this year’s near 3% pace to 2.5%

Overall, this is a budget that will help the core supporters of labour but leave the economy vulnerable to some future unforeseen shock. In terms of official short term interest rates, it means very little, as the path of the public finances is mainly unchanged, compared with the figures already taken into account by the Monetary Policy Committee. For now, with global growth healthy and UK domestic conditions supportive of growth, there seems little to worry about but a severe downturn would lead to problems for the government in the years ahead.

Market reaction to the Budget has been m uted
The chart shows that equity prices, at least for large companies, have continued to rise - and rise quite strongly from a near 6,000 low for the footsie 2 weeks ago. This signifies that the global financial wobble from the fall in the Shanghai stock market, and the comments about US recession from Greenspan, have been shrugged off. However, bond yields are higher, with the UK 10 year bond yield up by nearly 12 basis points this week.

UK economic data have been strong in Budget week, with annual retail price inflation hitting 4.6%, a 15 year high, and CPI inflation rising to 2.8% from 2.7% in January. Retail sales also rose strongly in February, by 1.4%, after a fall of 1.5% in January. This may, therefore, partly account for the rise in short term market interest rates, and we look for a base rate rise within the next two months, most likely in May but April cannot be completely ruled out.

The Budget does appear to have been broadly interest rate neutral, which means that it may have been the economic data this week that has driven market rates higher. The pound is higher as well, perhaps helped by the rise in interest rates and the recovery in equity markets. All in all, this is a Budget that, despite all of the political fall out and mixture of tax cuts and reduction in allowances, does not appear to have fazed the financial markets.

Trevor Williams, Chief Economist

Weekly economic data preview:
Final UK Q4 gdp and US inflation data top the release calendar

• We expect final UK Q4 gdp on Wednesday to be confirmed at 0.8% on the quarter. On Thursday, financial markets will concentrate on the latest CBI distributive trades' survey and consumer confidence on Friday to assess whether the rebound in retail sales in February continued in March. The BoE MPC will on Tuesday testify to the Treasury Committee on the February Inflation Report.

• After the Fed watered down its hawkish language last week, markets will focus on US new home sales today, consumer confidence on Tuesday and personal spending and inflation data on Friday. Markets last week raised the odds of a cut in US interest rates by year-end. Final Q4 gdp and the Chicago PMI will be published on Thursday.

• A busy week for the euro zone sees the release of the German IFO business survey on Tuesday, euro zone M3 money supply on Wednesday and euro zone consumer confidence and CPI inflation on Friday. Unemployment data from various member countries are due during the week and are forecast to underline a broadly positive economic environment where hiring is picking up.

The UK economic calendar slows down this week after a hectic schedule last week which saw CPI and RPI inflation re-accelerate in February to 2.8% and 4.6%, respectively. Stronger retail sales data for February underscored the positive backdrop for consumer spending. The latest CBI distributive trades survey on Thursday and consumer confidence on Friday are forecast to show that households remain in confident mood. UK economic data this month has on balance surprised to the upside and this will keep speculation alive that the Bank of England will have to raise interest rates this spring to bring inflation under control. The fact that MPC member Blanchflower boosted his reputation as an 'ultra-dove' on the committee by voting for a rate cut this month increases the risk that we could see a repeat\ of last year when the MPC was split with one member voting for higher rates and one other preferring lower rates. Final Q4 gdp data will be published on Wednesday and is not forecast to show any revision to the quarterly growth rate of 0.8%. Revisions to the gdp series recently though implies that the annual growth rate for Q4 or previous quarters could be adjusted up or down. Q4 current account figures will be released simultaneously with gdp on Wednesday and are forecast to show a reduction in the deficit from Q3 to £8.0bn, in part thanks to a smaller trade deficit. Away from the data, MPC member Gieve will deliver a speech on Monday and Chancellor Brown will on Thursday testify to the Treasury Committee on the economy and the measures introduced in the 2007 Budget last week.

A busy week for data watchers in the US promises to bring some news on consumer confidence, business investment and inflation. New home sales for February will be released on Monday and closely scrutinised after a severe 16.6% correction in January pushed new annualised home sales below the 1m mark to a near 4-year low. Data tomorrow is forecast to show that consumer optimism declined in March after touching a 5 1/2 year high in February. The Michigan and ABC confidence surveys both fell this month and suggest households may have become more cautious as they react to the crisis in the subprime mortgage market. Durable goods orders are due on Tuesday and are forecast to show a substantial 3.5% rebound in February from a steep 7.8% decline in January. Final Q4 gdp data on Thursday may be revised up a notch to 2.5% from 2.2%. The most important release in the US this week is reserved for Friday when the latest personal income and spending and core inflation data will be published. The data comes one week after the Fed stressed that inflation remains its predominant policy concern. Even though the Fed appears to have slightly toned down its hawkish stance, the fact that inflation has not moderated so far this year continues to preoccupy policy makers more than growth and means interest rates are likely to stay on hold at 5.25% for the foreseeable future, despite market expectations of a cut. We expect the annual core PCE rate, the Fed's preferred inflation measure, to have stayed unchanged at 2.3% in February. Data for personal income and spending are forecast to underline the healthy backdrop for the economy at a time when financial markets are becoming increasingly nervous that weakness in residential construction could spread to the rest of the economy.

In the euro zone, we expect the German IFO business survey on Tuesday to highlight that activity in manufacturing remains brisk and supportive of the view that the ECB may raise interest rates to 4.0% in Q2, despite a benign short-term outlook for inflation. Preliminary euro zone CPI for March will be released on Friday. ECB president Trichet will speak on Wednesday, Thursday and Friday.

Kenneth Broux, Economist
Lloyds TSB Bank,
Financial Markets
Faryners House,
25 Monument,
London EC3R 8BQ
0207 283 - 1000

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