Clegg Puts Britain's Budget Deficit Center Stage as Budd Redraws Forecast

Deputy Prime Minister Nick Clegg will say tackling Britain’s record deficit is the government’s top priority, as the independent budget office makes new forecasts that will be used for next week’s emergency budget.

“The extraordinary developments of the last few weeks in the euro zone matter enormously for the U.K.,” Clegg will say in a speech in London today, according to extracts released by his office. “Most immediately, they matter because the attitude of markets has changed. Markets have stopped believing that all European governments can service their debts.”

Echoing Clegg’s comments, Treasury officials said the U.K.’s underlying fiscal position is weak, suggesting Chancellor of the Exchequer George Osborne will stick to plans to reduce spending in the June 22 budget. The Conservative-Liberal Democrat coalition has warned the cuts will be the deepest since Margaret Thatcher was prime minister in the 1980s and will last longer than any other since World War II.

The Treasury officials said Osborne will focus on the size of the structural deficit to justify the need for greater fiscal austerity. The new Office for Budget Responsibility, headed by former Bank of England policy maker Alan Budd, will today provide a snapshot of the economy with new forecasts for both economic growth and the deficit.

The pound has fallen 10 percent against the dollar this year amid concern the government will struggle to fix the public finances.

Credit Rating

Fitch Ratings said last week that Cameron needs to accelerate budget-deficit cuts to protect Britain’s top credit rating. It said the U.K. is lagging behind other European countries in publishing deficit-reduction plans as investor concerns over government debt loads increase, and that the increase in debt in Britain had been faster than in any other AAA-rated country.

“There is strong political momentum for early fiscal consolidation,” said Michael Saunders, chief Western European economist at Citigroup Inc. in London. “The economics of fiscal consolidation are far more favorable than a few quarters ago. A pessimistic OBR assessment would simply set the stage for bigger fiscal tightening.”

Osborne put Budd at the helm of the budget office last month to provide economic predictions that are independent of government in an effort to depoliticize the forecasting process. Britain’s deficit swelled to a postwar record of 11.1 percent of gross domestic product in the year through March.

Structural Deficit

The Treasury officials said that if Budd forecasts weaker growth this year and lower trend growth than his Labour predecessor as chancellor, Alistair Darling, that will lead Osborne to assume a larger structural deficit. A structural deficit will not narrow as the economy recovers and will require spending cuts or tax increases to correct it.

In his last budget in March, before Labour lost the May 6 election, Darling said the economy would expand by as much as 3.5 percent this year and next. He also assumed the long-term growth average of 2.75 percent.

The six-week-old coalition is pinning the blame for the size of the deficit on Labour, which ruled Britain for 13 years. Gordon Brown was chancellor in Tony Blair’s government for 10 years before taking over as prime minister in 2007.

Prime Minister David Cameron said last week Brown left the public finances in a worse state than he anticipated and warned that the squeeze to come will “affect every single person in our country.” Darling said in March Britain would post a 167 billion-pound ($243 billion) deficit this fiscal year.

Value-Added Tax

Labour Party officials said Osborne is wrong to focus on the structural deficit, arguing there is no certainty about its size. The opposition is urging Osborne to take into account a 10 billion-pound narrowing of the budget shortfall since Darling’s March budget to soften the planned cuts to public spending. The officials said Labour is concerned Osborne is preparing the ground for an increase in value-added tax, a levy on sales, from 17.5 percent.

“If it turns out that borrowing is lower than I thought, then that puts a completely different complexion on things,” Darling said in an interview with the Guardian newspaper published June 12. He said that Osborne “is exaggerating the scale of the difficulties we face in order to justify the things he has wanted to do anyway.”

Fan Chart

Budd’s office today will break with Treasury tradition and publish the growth forecast it sees as most likely, alongside a fan chart which reflects the probability of missing that target. The change aligns the government’s forecasting practices with the Bank of England’s. Previously, the Treasury published a numerical range to reflect its view.

Budd’s forecast document, due to be more than 80 pages long, will also provide greater detail of the economic assumptions that underpin its predictions, stretching out over the full five-year forecast period.

The budget office will also include quarterly growth forecasts for this year and next and will include the effects of Private Finance Initiative borrowing on Britain’s debt.

Separately, the British Chambers of Commerce said today that Osborne should abandon his pledge to protect spending on the U.K. health service and development aid in his emergency budget. London Mayor Boris Johnson called on Osborne to keep to spending commitments on the capital’s infrastructure, including upgrades to the Underground subway system and construction of the planned Crossrail train service.

Osborne has already found more than 6 billion pounds in savings and is looking for further reductions to curb the budget shortfall. Defense Secretary Liam Fox yesterday refused to rule out cuts in military personnel, while Justice Secretary Kenneth Clarke told Sky News that “we cannot afford” to keep paying legal aid at current levels.

To contact the reporter on this story: Gonzalo Vina in London at gvina@bloomberg.net.

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