Darling's Budget smacks of unfounded optimism

The reaction of the UK indices to Alistair Darling’s Budget was somewhat subdued, which will have come as a relief to those investors who had feared the Chancellor’s announcement would trigger another market drop. However, Darling’s words of optimism that the UK’s worst economic performance since World War II would be followed by economic growth just one year later, paint a far rosier picture than most economists are predicting.

The Chancellor began his address with forecasts for economic production over the coming years. He said the UK economy is set to shrink by 3.5% in 2009, including a contraction of 1.6% in the current quarter, but that by the end of 2010 GDP would be showing growth again—to the tune of 1.25%, which would increase to 3.5% growth annually from 2011 onwards.

It is no wonder that this description of a relatively short, sharp shock to the economy, followed by imminent growth in a mere matter of months’ time, had little negative impact on the stock market on Wednesday: the picture illustrated by most economists has been considerably less rosy. Consensus estimates are for signs of growth to not emerge until mid-2010, leading to GDP growth of just 0.3% by the end of that year. Indeed, the International Monetary Fund (IMF) today forecast the UK economy to shrink by 4.1% in 2009 and a further 0.4% in the following year. Overall, the IMF sees the global economy contracting by 1.3% this year, its first contraction since the Second World War, improving to an historically-weak 1.9% growth rate in 2010.

While Darling was extolling the current British government’s steps to deal with the economic crisis and pulling his sanguine growth forecasts from the battered, red briefcase, the IMF was warning that the global outlook continues to be “exceptionally uncertain, with risks still weighing on the downside.”

Commenting on the Chancellor’s growth forecasts, Tony McGough, director of economic forecasting at global real estate adviser DTZ, said: “The government’s assumption that we will be back to economic growth by the end of this year, early next year, is optimistic.”

McGough’s reaction was relatively sedate compared to some, including chief executive of the Centre for Economics and Business Research, Douglas McWilliams, who expressed disbelief at Darling’s estimates. “He is forecasting an unbelievable 3.5% growth in 2011—a rate of growth about double what most economists (including CEBR) expect and higher than any reputable forecaster is assuming.”

Director general of the Confederation of British Industry (CBI), Richard Lambert, said the organisation’s initial reaction to the Budget is that it fails to set out a credible and rigorous path for restoring the public finances to health. The CBI itself forecast earlier this week that signs of an economic recovery would not be seen until this time next year.

Economists weren’t the only ones criticising Darling’s announcement. Conservative leader David Cameron was particularly and predictably potent in his riposte. The Budget is "completely inadequate" at addressing long-term problems, Cameron said, the government's economic model "fundamentally bust," and the government itself one of "the living dead."

Of course, the Chancellor’s predictions for future economic growth weren’t the figures under the microscope. Darling also announced that public borrowing is to rise to £175 billion this year, amounting to 12% of national GDP, and that £220 billion of government bonds will need to be sold this year—considerably more than previous outlined. Total government debt is set to soar to 79% of the UK’s GDP by 2013-14 from 59% currently, Darling said.

Included in moves prescribed by the government to counteract the recession and kickstart a recovery are: an increase in the rate of income tax on high earners to 50% on all income above £150,000 a year, starting April 2010—note, however, that the wealthy have an uncanny ability to avoid tax measures; an extension of the stamp duty ‘holiday’ for homes up to £175,000 until the end of the year; £500 million of extra finance for the construction industry to help housebuilders’ borrowing; a hike in the total annual limit for ISAs to £10,200; and the introduction of a scheme whereby motorists can save £2,000 on the purchase of a new car when they trade in a car of more than ten years age.

Among those Budget announcements that tend to get the most air time, alcohol and cigarette taxes are to rise by 2% from midnight tonight, while fuel duty will increase by 2 pence from September of this year.