Economic squeeze 'may get worse'


Businessman shaking money out of a piggy bank

An extra year of austerity measures could be in prospect if official forecasts published next week show Britain's public finances are in even worse shape than previously thought.

Some economists fear the figures will show the structural deficit - that part of the deficit which cannot be eliminated by economic growth - could be revised up implying a spending squeeze prolonged until 2019/20.

The Government is already facing an angry backlash after refusing to give an across the board pay rise to NHS workers but some experts believe the worst of the fiscal tightening is yet to come.

Forecasts from the independent Office for Budget Responsibility (OBR) will be released alongside the Budget on Wednesday.

They may give George Osborne a partial boost by nudging up economic growth predictions for 2014 and paring back expected public sector borrowing figures for the next few years.

But the deficit is still high and the Chancellor will have to perform a "balancing act" between delivering pre-election sweeteners and sticking to a prudent course, according to Alan Clarke of Scotiabank.

It is the structural deficit which gives some economists particular cause for concern, with a recent Financial Times analysis, replicating the models used by the OBR, suggesting Mr Osborne may be facing a £20 billion black hole in the public finances.

This is because, according to the calculations, indicators including rapidly falling unemployment suggest there is little spare capacity left to continue growing the economy rapidly over the next few years.

Without such expansion to boost the Treasury's coffers, more of the money to eliminate the deficit would have to come from tax rises or spending cuts - and according to the FT figures, Britain might have to undergo an extra year of austerity.

On a brighter note, some economists expect the OBR to lift forecasts for this year's growth. It currently predicts gross domestic product (GDP) to rise by 2.4%, but it could lift this closer to the Bank of England's latest forecast of 3.4%.

Meanwhile, Scotiabank expects the official public sector borrowing forecasts to be shaved back by around £2 billion to £109 billion for the current financial year.

Roger Bootle and Jonathan Loynes of Capital Economics said: "Although the forecasts for public borrowing in the next few years could come down a bit, the OBR may judge that the amount of this year's budget deficit that is structural and hence will not be eliminated by the economic recovery is greater than it thought before.

"This would prompt it to revise up its forecasts for cyclically-adjusted borrowing in future years, implying that the eventual fiscal tightening needed to return the public finances to full health will be even bigger.

"Overall, this Budget is unlikely to steer the economy towards a dramatically different course, nor to change the harsh reality that the worst of the fiscal squeeze is yet to come."

However, Investec's Philip Shaw expressed scepticism about the "inexact science" used to measure spare capacity or output gap in the economy, which might worsen the outlook for the structural deficit and therefore signal a need for more austerity.

"This forms a perfect example on how policy makers are beginning to lean excessively on their estimates of the output gap," he said.

The shrinking value of the pound

The shrinking value of the pound