Public spending fears deepen gloom

BCC says economy languishing in the doldrums, Concern grows that Brown will tighten purse strings

The British economy is languishing "in the doldrums" a leading business organisation warned today as fears mounted that the Government is about impose a clampdown on public spending.

The British Chambers of Commerce said further cuts in interest rates were needed to boost the economy unless the global recovery rebounded soon.

It said the recovery in the second quarter of the year had been "feeble" with the rebound in the once-booming services sector even weaker than the revival in manufacturing.

The gloomy report came as speculation grew that Gordon Brown, the Chancellor, will impose a tight spending settlement in the upcoming Cabinet negotiations.

The move was being seen as a bid to head off talk of further tax rises following official figures on Friday showing public spending was in danger of running out of control.

Central government spending surged 14 per cent in the first three months of the fiscal year compared with a target of 6.8 per cent for the full year. Net investment has so risen by an astonishing 180 per cent.

Analysts believe that with tax revenues undershooting the Budget forecasts, the public finances could plunge into a £37bn deficit this year. Against this background, Mr Brown is drawing up the spending round for the three years after the current deal elapses in 2006.

However as the NHS has already secured a deal guaranteeing spending growth rising to more than 7 per cent a year by 2007-8, there are fears other departments will have to accept a freeze.

A Treasury spokeswoman declined to comment on speculation, saying any decisions would be taken in the next spending review.

"We will stick to our tough fiscal rules," she said. "Decisions for the next spending round are a matter for next year."

The Treasury is relying a return to above-trend growth next year and in 2005 to boost revenues and fund his spending his plans without raising taxes.

However the BCC report showed both manufacturing and services sectors were significantly weaker than for most of 2002 despite a modest improvement over the last quarter.

"There is no sign of a sustainable recovery," said David Frost, its director general. "We hope that the Bank will persevere with its flexible stance and be prepared to act again if circumstances worsen."

He added that, given the choice, he would prefer another rate cut by the European Central Bank to boost demand among continental firms for British goods and services.

But he said that interest rates on their own would not be able to underpin a recovery. "Given the dangers to the economy, the Government must be ready to take further action to ease the tax and regulatory burden."

However he acknowledged the state of the public finances - which last week showed a cumulative £14bn deficit this year - meant it was unlikely the Government would be able to cut taxes.

"Business has clearly paid an increased amount of tax and the National Insurance rise has been a key a part of that," he said.

Meanwhile the Ernst & Young ITEM Club, an independent forecast unit that uses the Treasury's model, yesterday forecast sluggish GDP growth of 1.7 per cent this year, and 2.5 per cent.

This would mean growth would undershoot the Chancellor's targets. It said the public finances would plunge £10bn deeper into the red over the next two years.

However it said there would be no purpose in cutting rates from their current 48-year low of 3.5 per cent unless there was a housing market crash.

Any additional monetary stimulus would not have an impact until next year, by which time the economy will have returned to trend growth, risking a return to boom and bust, the report said.