By David Robinson and William Wilkes

LONDON (MNI) – Wednesday’s budget for financial year 2011-2012 will
reveal how UK Chancellor of the Exchequer George Osborne plans to
secure Britain’s economic recovery in a financial year which will see
public spending cut by more than 2% of GDP.

The forecasts accompanying the Budget look set show to
stronger-than-expected public finances and weaker-than-expected growth.
Osborne’s juggling act will centre on using the improvement in the
public finances to fund low cost initiatives designed to bolster growth.

A shock 0.6% fall in output in Q4 2010 focussed concerns on the
underlying strength of the UK’s economic recovery and when the
independent Office for Budget Responsibility issues its forecasts
Wednesday, it looks set to cut its near-term growth projections.

The OBR, in its November Economic and Fiscal Outlook, was for 1.8%
growth in 2010, 2.1% growth in 2011 and 2.6% growth in 2012. The
Treasury’s most recent compilation of independent forecasters shows that
the average prediction is for growth of just 1.8% this year and 2.1%
next.

While the news on growth looks gloomy, a brighter spot for Osborne
is that the public finances looks set to outperform the OBR’s
projections. A combination of higher-than-expected inflation feeding
through to higher value added tax revenues and lower-than-expected
jobless benefit claims have helped the public finances.

The OBR forecasts public sector net borrowing ex-financial
interventions (PSNB-X) for 2010-11 at stg148.5 billion. Assuming no back
revisions, analysts’ median forecast for February’s PSNB-X is stg8 bln
which would put cumulative PSNB-X for Feb at stg121 bln, with only one
month of the fiscal year to go.

March is traditionally a big deficit month, but even a repeat of
last March’s just shy of stg20 billion increase in PSNB would still
leave 2010-11 borrowing at more than stg7 billion less than the OBR
predicted, giving the Government some scope for a giveaway in the
Budget.

“There is a little bit of redistribution that can be made,” Vicky
Pryce, now Senior Managing Director at FTI Consulting and until recently
joint head of the Government Economic Service, told Market News.

Pryce expects the government to boost capital allowances, with
any increased investment showing up in the growth numbers.

“What you really want to do is make sure that investment stays up.
Government investment is going down, you want to make sure private
investment goes up,” she added.

“The thing that businesses really have been asking for, and they
might get – you could argue whether it is costly or not – is capital
allowances,” Pryce said.

“What they do is they encourage investment up front, they only last
about a year and that, of course, stimulates the economy this year if
that’s what you want to see happen,” she added.

Economic research suggests raising capital allowances and providing
business with tax incentives to invest can strengten growth.

“There is a lot of evidence that it has worked… generally, if you
look at tax incentives, capital allowances, in the year that they are
applied lead to a bringing-forward of investment,” Pryce said.

With consumers’ finances under intense pressure, trying to
strengthen corporate investment may make more sense than helping
shoppers as the risk is consumers would simply choose to save more.

There has been some speculation that the Chancellor will announce
plans to merge National Insurance and Income Taxes in order to simplify
taxation for smaller businesses which do not have dedicated payroll
teams.

Many pundits have also suggested that the move would make political
sense for Osborne as a combined income/national insurance tax would show
the basic income tax rate is effectively 31p in the pound, not the 20p
it appears to be now, and could thus rally support for his program of
spending cuts.

Other measures expected include a reduction in the headline rate of
corporation tax from 28% to 27% and 20% for smaller businesses – a move
that would fit neatly into the “Budget for Growth” narrative.

Osborne has also repeatedly made clear he is considering postponing
at least part of the 3.7p per litre rise in fuel duty scheduled for
April 1, in order to relieve pressure on motorists struggling with
rises in petrol prices.

“I’m looking very carefully at that (fuel duty rise), seeing
whether we can afford to do something about that,” Osborne said in a BBC
interview Sunday.

OBR To Cut 2011 Growth Forecast, But Will It Raise 2012 On ?

Once Osborne finishes his self-styled “Budget for Growth”
Wednesday, the OBR will issue its full set of forecasts.

While the consensus view is that it will cut its 2011 growth
forecast, in light of recent surprisingly weak growth data, there is
less certain about what will happen to its forecast in following years.

Geoff Dicks, a founding member of the OBR, says that on the OBR’s
model softer than forecast growth feeds through to a widener output gap,
and in theory this should feed through to faster growth ahead.

The shock 0.6% fall in Q4 GDP alone feeds through to a 1.2%
shortfall in the GDP level compared to the November OBR forecast, and
what the OBR could do is follow the logic of its model and add this lost
growth on to its medium-term projections.

Dicks urges the OBR not to do this, and to find a way of tweaking
its forecasts so it does not end up damaging its credibility by coming
up with even further above consensus forecasts than it has now.

He says the OBR could lower its forecast for trend growth, of 2.35%
up to the end of 2013 and 2.1% after that, or reassess the amount of
spare capacity in light of cyclical indicators.

—London Bureau; Tel: +44207 862 7491; email:
drobinson@marketnews.com/wwilkes@marketnews.com

[TOPICS: MABDS$,M$B$$$]