Government borrowing figure shrinks

Government borrowing is shrinking, according to figures published yesterday. News of the favourable trend comes ahead of tomorrow's report from the National Audit Office which is likely to claim that the outlook for the public finances published in last November's Budget was too optimistic.

The report is expected to prepare the ground for additional tax rises in the Budget on 2 July. Fears that companies will have to shoulder the higher tax burden because of Labour's manifesto pledges on income tax helped push share prices lower again yesterday.

The FTSE 100 index ended nearly 63 points lower at 4,682.2, its second successive fall. An opening decline in shares on Wall Street following buoyant figures for US industrial output also contributed, although the Dow Jones index later climbed above 7,800.

The Public Sector Borrowing Requirement (PSBR) was bigger than expected at just under pounds 4bn in May, but its total in the first two months this financial year was only pounds 4bn compared to pounds 6.2bn at the same stage last year.

"The public finances are improving rapidly. The only reason for casting doubt on this is to create room for manoeuvre on government spending," said Kevin Gardiner, UK economist at investment bank Morgan Stanley.

Yesterday's figures showed that tax revenues are 4.5 per cent higher than at the same stage of the previous year, with VAT and income tax especially buoyant. More importantly, departmental spending is 3 per cent lower than in the first two months of 1996/97. Even adjusting for items like the sale of the MoD married quarters, underlying expenditure is flat.

With all the signs that it will be increasingly hard to stick to the current spending plans, most economists are assuming the NAO report will be a prelude to modest tax increases on top of the windfall levy in next month's Budget.

The report could find a hole of several billion pounds in the plans inherited from Kenneth Clarke. It is expected to challenge the assumptions made last Budget about the economy's potential growth rate, forecast falls in unemployment and the possible savings from cracking down on tax and benefit fraud.

Yesterday's fall in share prices partly reflected fears the Chancellor will raise up to pounds 5bn a year from reducing or abolishing the tax credit on dividends for tax-exempt institutions.

It was also a reaction to yesterday's move on Wall Street, where the Dow Jones index was more than 51 points lower at 7718.71 shortly after opening. The impact of figures showing a bigger-than-expected jump in industrial output in May outweighed others showing tame consumer prices.

Manufacturing production jumped 0.4 per cent during the month. It was the tenth consecutive monthly increase after April's figure was revised up. Meanwhile headline inflation declined to 2.2 per cent from 2.5 per cent in April.