Golden rule: Will Brown break it?

The economy is currently strong but problems await the incoming government, according to the Ernst & Young ITEM Club.

The latest report from the economic forecasting group, released on Monday, predicted that Gordon Brown will have to break his 'golden rule' on government borrowing if Labour is re-elected next month, despite a recent boost to his books from roads spending being classed as investment.

The rule insists that borrowing is only for investment and balanced over the economic cycle.

With several major observers now saying there is a hole in the government's finances, which will have to be filled by higher borrowing or higher taxes, the chancellor has insisted that he will prove his critics wrong as he has in the past.

But the latest finding of a £12bn deficit from the ITEM Club, which uses the Treasury's own forecasting model, is a blow to Brown as he seeks to put the economy at the centre of Labour's re-election bid.

Growth

"The UK economy is looking strong with growth back on track for the next 12 months," the group said.

"Consumer confidence remains high and worries about rising mortgage rates and falling house prices are evaporating fast.

"ITEM continues to believe that any decline in house prices will be modest with no sign of a serious downturn.

"The economy is now being buoyed by manufacturing and services and continued growth in investment and employment – earnings are set to grow to nearly five per cent by the end of the year."

Chief economic advisor Professor Peter Spencer said: "It is very hard to see a major weakening in either the housing market or the high street against the background of such a stable economy."

However, he added: "The government approaches an election with the economy in pretty good shape.

"From May 6, however, there will be come real challenges that have to be addressed quickly and competently, or the UK faces longer term economic stagnation."

'Challenges'

These problems include closing Britain's savings gap between long-term commitments and money currently being put away, which the reports estimates is running at two to five per cent of GDP.

Other potential challenges are the low flat rate taxes being introduced in Eastern Europe, which could be copied by Germany and its financial services capital Frankfurt.

Shadow chancellor Oliver Letwin said Brown would raise taxes in a Labour third term to meet shortfalls in income.

"We have no reason to believe Mr Blair and Mr Brown when they say that the overdraft will disappear by itself," the Conservative said.

"We have every reason to believe the Institute for Fiscal Studies, the ITEM Club, the OECD and the IMF when they say that, with Labour’s spending plans, the only way of clearing the overdraft is to raise tax rates.

"Today, there is renewed speculation that Labour will use an increase in National Insurance – its tax of choice – to plug the gap.

"But there is also mounting evidence that Mr Blair is planning to raise council tax by stealth."