Budget 2009 Preview - The great borrowing binge goes on

Chancellor Alistair Darling faces the unenviable task in his second Budget of trying to offer the economy some much-needed support, whilst at the same time reassuring the markets that the public finances will eventually return to health. He is unlikely to achieve either aim convincingly.

If Mr Darling thought that his first Budget last year was a difficult one, he cannot have imagined just how much worse the situation would be a year later. For a start, he will have to concede that the economy will now contract much more sharply this year than he previously expected, while next year’s recovery may also be weaker.

Needless to say, this will have extremely adverse effects on the already disastrous state of the public finances.But there are growing signs too of a structural hole emerging in the fiscal position, perhaps reflecting the tax-unfavourable shape of growth. Meanwhile, Mr Darling may have to make some allowance for the cost of the measures to support the banking sector.

Overall, we expect the official forecasts for public borrowing to rise by a total of some £250bn over the next five years compared to those presented in the PBR. As a result, the ratio of debt to GDP will rise above 70%. Our own forecasts for both borrowing and debt are even higher.

Against that background, the scope for a further boost for the economy in this Budget is severely limited. Whilst we expect a small giveaway in the next year or two, this is likely to turn into a net fiscal tightening further ahead. Possible measures include the bringing forward of further capital spending plans and extra help for the unemployed. A further rise in the top rate of income tax or in VAT could help to bring borrowing back down somewhat further ahead.

But the Chancellor is unlikely to provide much reassurance over the longer-term health of the public finances. Without further action, it could now be a decade before public sector debt starts to fall as a proportion of GDP and a generation or more before it returns to current levels.

None of this means that the UK government is in danger of bankruptcy. Neither do we expect the prospect of huge amounts of issuance to push bond yields sharply higher in an environment of very low interest rates and inflation. But it once again underlines the need for a huge fiscal consolidation as and when the economy finally emerges from this recession.

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