British public borrowing is set to rise and the government will need to raise taxes or reduce spending to decisively cut the deficit, the Organisation for Economic Cooperation and Development said yesterday.
The OECD's assessment in its twice-yearly outlook echoes the views of many domestic forecasters and comes as Chancellor of the Exchequer Gordon Brown prepares to deliver his pre-Budget report tomorrow.
"The government deficit is likely to be above three per cent of GDP in 2004 and, in the absence of a spontaneous rise in taxes, additional action may be required to achieve a decisive and sustainable reduction," the OECD said.
Increases in tax revenues from oil companies and an overall improvement in corporate revenues are likely next year, the OECD said. But those may not be enough to offset planned nominal spending increases of about 12 per cent through 2006, "so... the deficit is likely to increase slightly."
The OECD trimmed its forecast for British economic growth in 2005 to 2.7 per cent from the 2.8 per cent it predicted six months ago, while it raised its forecast for the current year to 3.2 per cent from 3.1 per cent.
The slowdown in the British economy means the Bank of England can afford to leave interest rates steady at 4.75 per cent, although the OECD forecasts that base rates will rise to 5.50 per cent by the end of next year.
By contrast, most British forecasters are predicting that rates are close to their peak or have already reached it. Many in financial markets have begun to place bets that rates will have to be cut next year.
The OECD repeated its warning that the British property market - which has seen double-digit growth since the late 1990s and has recently shown signs of rapid cooling - remains a major threat to the economic outlook.
"A more pronounced drop in house prices leading to an abrupt fall in consumption remains a risk, although one that may be diminishing as the likelihood of a soft landing for the whole economy increases," the report said.
Still, even moderate falls in house prices could cause significant deceleration in consumption growth and would likely boost the savings ratio by 1.5 percentage points over the next year back towards its long-term average, the OECD said.
"Instability stemming from the housing market remains a risk, although it may be smaller than at previous house price peaks," the report added.
The OECD said a property market crash was less likely given the fact that interest rate hikes have not been of the same magnitude as before previous declines in house prices. Rates have risen just 1.25 percentage points in a year compared with around four to five percentage points in the past.
"As such a rise in interest rates appears inconceivable in present circumstances, a marked house price fall seems less likely than in the past," the OECD said.