U.K. Budget Deficit Balloons to Widest Since 1946 (Update1)

By Mark Deen and Gonzalo Vina

July 18 (Bloomberg) -- The U.K. budget deficit ballooned to the widest since records started in 1946, putting pressure on Prime Minister Gordon Brown to ease decade-old borrowing rules.

The shortfall rose to 24.4 billion pounds ($49 billion) in the three months through June, the Office for National Statistics said today. Last month, the deficit widened to 9.2 billion pounds, more than the median forecast of 7.4 billion pounds in a Bloomberg News survey of 17 economists.

Brown's rules are buckling as the economy edges towards its first recession since the early 1990s, forcing borrowing higher. The government, which has already cut taxes this year, may find it hard to meet its March forecast of a 43 billion-pound deficit this year as revenues wane. Government bond yields rose today.

``The credibility of the policy framework is going to take a major knock,'' said Nick Kounis, chief European economist at Fortis Bank in Amsterdam and a former U.K. Treasury official. ``Whatever move is made to the goalposts now is reducing credibility, which is why you see sterling easing this morning.''

Chancellor of the Exchequer Alistair Darling may change Britain's rules for government spending later this year, a Treasury spokesman said yesterday. He dismissed a Financial Times report that the exercise would result in higher borrowing and spending as ``pure speculation.''

Weaker Pound

The British pound fell to $1.9933 as of 9:49 a.m. in London, from $2.0038 late yesterday. It declined to 79.53 pence per euro from 79.16 pence. U.K. government bonds declined, with the yield on the two-year note rising 6 basis points to 5.01 percent.

Economists say Brown is at risk of breaching the fiscal rules he created as finance minister in 1997, when he promised to borrow only for investment over the economic cycle and keep debt below 40 percent of economic output.

Treasury officials will decide whether to change the rules when the ONS publishes annual revisions to growth later this year, which may show when the current economic cycle ends.

The pound has dropped 12 percent in the past year against the currencies of its major trading partners as the run on Northern Rock Plc and a housing-market slump eroded confidence in the economy.

``It's the end of the Brown era of economics,'' George Osborne, opposition treasury spokesman for the Conservatives, told BBC Radio 4. ``He's put his credibility on these fiscal rules. The first economic downturn that the world has faced, and he's abandoned them.''

Dip in Growth

The present economic cycle, according to the Treasury, began in 1997. Darling's annual budget in March said it was ``too soon to assess'' whether a dip in growth in the second half of 2006 marked an end to the cycle.

A cash-based measure showed the deficit was 15.5 billion pounds in June, the highest for the month since records started in 1984, compared with 10 billion pounds a year earlier. Economists forecast a shortfall of 12.6 billion pounds.

``The figures were horrific, absolutely horrific,'' said Philip Shaw, chief economist at Investec Securities in London. ``Faced with a choice of tightening fiscal policy, breaking both the rules or changing them, the Government seems to be opting for the third choice.''

Forecasting growth of more than 2 percent this year and next, Darling is more optimistic than economists. Bank of England Governor Mervyn King says Britain may slip into a recession as the worst housing slump since the early 1990s deepens.

Tax Revenue

The slowdown threatens to cut revenue from consumer spending, housing transactions and company profits. An increase in receipts from North Sea companies, which are profiting from oil prices that reached a record above $147 a barrel last week, may not be enough to make up the loss, according to the London-based Institute for Fiscal Studies.

``The government would perhaps have been better off rethinking how these rules should look rather before the point at which it looks as though you are just about to break them,'' Robert Chote, director of the Institute for Fiscal Studies, told BBC Radio 4. ``That doesn't do credibility any good in its own right.''

In June alone, taxes increased just 2.5 percent, with receipts of value-added tax falling 4.6 percent. Corporation tax rose 0.3 percent and income tax gained 1.7 percent. Spending rose 6.9 percent.

In May, Darling announced a 2.7 billion-pound emergency tax for 22 million people, and this week he postponed for six months an increase in fuel duty to cushion motorists from the surge in oil prices. The delay will cost the Treasury 550 million pounds this year.

Poll Ratings

The prospect of a recession is eroding support for Brown, who has until June 2010 to hold the next general election. The Conservatives, led by David Cameron, had a 22 percent point lead over Labour in a YouGov Plc survey published on July 13.

Net debt stood at 38.3 percent of GDP in June, the highest since July 1999, the statistics office said. Including the liabilities of Northern Rock, the mortgage lender taken into temporary state ownership in February after its funding dried up, debt was 44.2 percent of GDP.

The current budget, which excludes investment, showed a deficit of 7.6 billion pounds in June and 20.4 billion pounds for the first three months of the fiscal year, up from 12.5 billion pounds a year earlier and the highest quarterly shortfall since 1946.

To contact the reporters on this story: Mark Deen in London at Jryan13@bloomberg.net Gonzalo Vina in London at gvina@bloomberg.net

Last Updated: July 18, 2008 05:52 EDT

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