Economic Pressure Grows For U.K.

25.02.2012

The man behind the U.K. government's aggressive cost-cutting plans, Treasury chief George Osborne, is facing increasing pressure—including from within his own Conservative Party—to resuscitate Britain's still-sluggish economy with tax cuts and other stimulus measures.

Mr. Osborne and the government have made debt reduction the top priority, having embarked on a multiyear plan to cut tens of billions of pounds of spending in areas including welfare, policing and defense.

But the continuing economic malaise has cracked the door open for friends and foes alike to press Mr. Osborne to introduce tax cuts and other measures when he unveils the U.K. budget on March 21.

Liam Fox, a former government minister and leading cheerleader for the Conservatives' right wing, in recent days publicly called on the chancellor to reduce taxes on employment, arguing that it would make it less expensive to hire workers.

The opposition Labour Party claims the government is choking growth by cutting too far and too fast. Labour argues for stimulating demand in the short term with moves like a reversal in an increase in sales tax. Meanwhile, the Liberal Democrats—the coalition government's junior partner—are pressing for an income-tax break in the budget to ease the burden on lower-income families.

Mr. Osborne, whose Conservatives are neck and neck with Labour in voter-opinion polls, is conscious of the need for public support. According to pollsters ComRes, 51% of Britons believe the government is cutting too much and too quickly, underscoring that while the government has largely convinced the markets of the soundness of its fiscal plans, it hasn't convinced the voting public.

The U.K.'s economic recovery has been lower than expected, despite relatively low interest rates. Official data released Friday confirmed the economy shrank in the fourth quarter of 2011, largely driven by a significant drop in business investment, while growth for the year as a whole was weaker than initially though as a result of weaker production. Meanwhile, unemployment has been rising, and the government in November was forced to admit that it will have to borrow more than planned in coming years.

Economists say the recent downgrade warning from Moody's Investors Service Inc., even as it encouraged the government to stay the course with its debt-reduction program, decreased the likelihood that Mr. Osborne will respond to the chorus with significant tax cuts or spending increases in his budget. While he may make some minor tax tweaks to promote growth—such as initiatives to promote construction—any moves would be expected to be revenue neutral, as was the case in the government's last budget update in November.

"The aim of the budget is neither giving nor taking away," said Michael Saunders, a U.K. economist at Citigroup.

Mr. Saunders said that, for instance, moves could include those such as increasing the amount on which people don't have to pay income tax, to help lower-income families, while reducing the amount of pension tax relief enjoyed by people on high salaries—something the Liberal Democrats, the junior member in the Conservative-led coalition, are pushing for.

The U.K. Treasury declined to comment on budget plans, but Mr. Osborne has recently said publicly that he plans to stick with his cost-cutting program and that the Moody's announcement validated his approach.

He has long argued that a return to sustained growth is impossible unless there is a debt-cutting program that bond investors find credible, and thereby keep long-term interest rates low.

On Friday, the Office for National Statistics said the U.K. economy contracted 0.2% in the final three months of 2011, in line with an earlier estimate, largely due to a slump in business investment.

Business investment shrank 5.6% in the fourth quarter compared with the third, falling £1.7 billion ($2.28 billion) to £28.7 billion, the ONS said. Economists blamed the collapse in investment on the fallout from the sovereign-debt turmoil in the neighboring euro zone.