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Viewing cable 08LONDON3097, Government's Pre-Budget Report: Too Bullish, Too Risky,

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Reference ID Created Released Classification Origin
08LONDON3097 2008-12-11 16:42 2011-08-25 00:00 UNCLASSIFIED//FOR OFFICIAL USE ONLY Embassy London
VZCZCXRO3961
PP RUEHAG RUEHDF RUEHIK RUEHLZ RUEHROV RUEHSR
DE RUEHLO #3097/01 3461642
ZNR UUUUU ZZH
P 111642Z DEC 08
FM AMEMBASSY LONDON
TO RUEHC/SECSTATE WASHDC PRIORITY 0656
INFO RUCNMEM/EU MEMBER STATES COLLECTIVE PRIORITY
RUCPDOC/DEPT OF COMMERCE WASHDC PRIORITY
RUEATRS/DEPT OF TREASURY WASHDC PRIORITY
RUEHBL/AMCONSUL BELFAST PRIORITY 1185
RUEHED/AMCONSUL EDINBURGH PRIORITY 1036
UNCLAS SECTION 01 OF 02 LONDON 003097 
 
SENSITIVE 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON EFIN ETRD EINV UK
SUBJECT:  Government's Pre-Budget Report: Too Bullish, Too Risky, 
Say Critics 
 
REF:  LONDON 02970 
 
LONDON 00003097  001.2 OF 002 
 
 
1.  (SBU) Summary:  The Pre-Budget Report (PBR), announced on 
November 24, has been widely criticized, from the size and nature of 
HM Treasury's fiscal stimulus package to HMT's perceived overly 
optimistic macroeconomic forecasts.  On December 10, the Chancellor 
of the Exchequer Darling defended the PBR before MPs on the Treasury 
Select Committee.  He explained the necessity of the fiscal package, 
dismissed concerns of deflation, and defended HMT's claim that the 
economy will start to recover in the second half of 2009.  Prior to 
the Chancellor's appearance in front of the Committee, HMT officials 
met with MPs to explain the assumptions used to determine the 
macroeconomic forecast, the importance of the fiscal stimulus 
package and the reasoning behind abandoning HMG's fiscal rules. 
Independent economists told the Committee that HMT's forecast was 
optimistic and cautioned that any recovery would be contingent on 
increased bank lending.  They expressed concern that public finances 
will not rebound as quickly as HMT expects.  End Summary. 
 
Chancellor Defends Pre-Budget Report 
------------------------------------ 
 
2.  (U) Chancellor Alistair Darling defended his Pre-budget Report 
(PBR) before MPs on the Treasury Select Committee December 10.  He 
maintained support for the macroeconomic forecasts made in the 
November 24 PBR (see reftel) - particularly that UK economic 
recovery will start in the second half of 2009.  He said the 
forecast was consistent with the Bank of England's independent 
forecast and said the recovery will be aided by a low interest rate, 
the fiscal stimulus package, lower inflation and a flexible economy. 
 He acknowledged that any recovery will be influenced by bank 
lending and said he will meet with his new lending panel and the 
chief executives of major banks December 11 to discuss strategies to 
increase lending.  The Chancellor dismissed concerns of sustained 
deflation, saying that as the economy recovers, the summer's 
inflationary pressures will likely return.  He welcomed 
President-elect Obama's calls for further U.S. fiscal stimulus.  He 
said the UK's fiscal stimulus package was "absolutely necessary" and 
that if HMG had allowed the recession to become deeper and longer, 
the cost of doing nothing might have outweighed the cost of doing 
something. 
 
HMT's Macroeconomic Forecast: The Verdict 
----------------------------------------- 
 
2.  (U) Dave Ramsden, HM Treasury's Chief Economic Adviser, defended 
the government's macroeconomic forecast before Treasury Select 
Committee MPs on December 9.  Under heavy questioning from 
Conservative members of the Committee, Ramsden said the forecast for 
an economic recovery beginning July 2009 was underpinned by four 
factors: a sharp fall-back in commodity prices that will support 
household incomes; a large fall in interest rates; the fiscal 
stimulus package; and a significant depreciation in sterling.  While 
HMT expects output to fall at the beginning of next year, these 
forces, he argued, will lead to a recovery gathering pace in 2010. 
He assured the Committee that HMT has not underplayed the risks to 
growth but acknowledged that the Treasury's view was not shared by 
all independent forecasters. 
 
3.  (U) Independent experts who appeared before the Committee 
December 4 were less optimistic about the UK's outlook.  Robert 
Chote, Director of the Institute for Fiscal Studies, said the PBR 
assumption that the stimulus package would reduce the depth of the 
downturn by about 0.5 percent was reliant on international action. 
If the UK's package was not accompanied by similar measures 
internationally, other countries, and not the UK, might reap the 
benefits of the UK's package.  The economists criticized the 
Chancellor's statement that the UK was more resilient than other 
economies, saying the UK's high levels of household debt, massive 
housing bubble, and large financial sector left the UK badly placed 
to cope with a banking crisis.  Roger Bootle, of Capital Economics, 
told MPs that getting banks lending again was critical to any 
recovery.  A self-proclaimed free-marketer, he shocked MPs by 
calling on HMT to adopt the post World War II monetary policy of 
directed bank lending.  He said HMG can't continue "encouraging" 
banks to lend.  If banks continued to resist the stern warnings from 
the Chancellor, HMG would have to force lending.  Bootle added that 
banks will be cautious to the point of reckless and will not act in 
the collective interest unless forced. 
 
The Fiscal Stimulus: Temporary, Timely, Targeted 
--------------------------------------------- -- 
 
4.  (SBU) HMT officials told MPs that the fiscal stimulus package 
was designed to be temporary, timely, and targeted.  They said the 
package introduced in the PBR met all three criteria.  However, the 
Committee's independent witnesses were critical of HMT's use of a 
 
LONDON 00003097  002.2 OF 002 
 
 
VAT reduction.  Simon Kirby, of the National Institute of Economic 
and Social Research, told MPs that trying to stimulate spending in a 
credit crunch without addressing the problem of credit constraints 
will have minimal impact.  Professor Colin Talbot, of the University 
of Manchester, was worried that the VAT reduction could prove 
deflationary.  If there is any stimulus effect, he said, it will be 
loaded towards the end of the VAT reduction period (end of 2009). 
(Comment:  These views are in line with comments made to econoff by 
bank economists about the potential impact of the VAT reduction.) 
 
Farewell To The Fiscal Rules 
---------------------------- 
 
5.  (U) HMT officials said the fiscal rules on debt were used to 
meet three objectives: achieve sustainable public finances in the 
medium term, protect investment, and support monetary policy in 
stabilizing the economy.  (Note: HMG's two self-imposed fiscal rules 
were: the 'golden rule' that HMG will only borrow to invest and the 
'sustainable investment rule' that public sector net debt will 
remain below 40 percent of GDP.  End note.)  Ramsden said against 
the background of a credit crunch it would be perverse to stick to 
these rules.  Therefore, the Chancellor's PBR announced that HMT has 
"temporarily departed" from the rules and now abides by a temporary 
operating rule that requires HMG to "set policies to improve the 
cyclically-adjusted budget each year...so it reaches balance and 
debt is falling as a proportion of GDP once the global shocks have 
worked their way through the economy."  Ramsden said HMT has not 
established a definite end date for the temporary rule.  He could 
not say whether HMT will ever return to the previous fiscal rules. 
 
 
6.  (U) During the Treasury Committee's session with independent 
experts, Chote told MPs that the new temporary operating rule fails 
to act as a constraint on government actions.  The economists were 
also skeptical of the Chancellor's forecasts for the public 
finances.  According to the PBR, HMT expects tax receipts, as a 
proportion of GDP, to return to 2007-2008 levels by 2013-2014.  The 
economists said that in normal circumstances, tax receipts do not 
return so quickly after a recession.  They also warned that the 
extent of the government debt will become an increasingly important 
factor in the cost of the debt.  Eventually, borrowing will become 
significantly more expensive and its cost will begin to pose a 
considerable constraint on future borrowing. 
 
TUTTLE