Major warns against early rise in taxes

THE PRIME Minister yesterday urged caution on the Chancellor over his plans to raise taxes to bring down the record level of borrowing in his next Budget.

John Major also called for the currencies of United States, Japan and the European Community to be linked, a demand that could prevent Britain's re-entry to the exchange rate mechanism for the foreseeable future.

While not ruling out some tax increases, Mr Major made it clear that he does not want Norman Lamont - possibly facing his last Budget - to be panicked into short-term action to reduce the projected pounds 44bn public sector borrowing requirement.

'The borrowing requirement is too high . . . but it's not all that long ago that the objective of policy was to have the public sector deficit at around 1 per cent of gross domestic product.

'The underlying deficit at the moment is not all that much higher now. Although the problem needs to be dealt with - and I don't push it aside - I think sometimes people overestimate the difficulty of dealing with it over the medium term,' Mr Major said in a BBC television interview with Sir David Frost.

Mr Major's intervention, before Mr Lamont's pre-Budget summit of ministers at Chevening next weekend, will intensify the speculation about growing tensions between the Prime Minister and his Chancellor.

Analysts said prices of gilt- edged stocks would fall on worries about the size of the borrowing requirement. Investors - particularly from overseas - want assurance that the Government will reduce its borrowings through tax increases or other measures before they buy further gilts.

Mr Major refused to repeat election pledges that the value- added tax base would not be widened. But one of seven economists who advise the Chancellor said the economy was too fragile to sustain increases in taxation this year. Tax increases could pitch the Government back into a political crisis, when it is talking up hopes of recovery.

Some of the Treasury team share Mr Major's more optimistic view that borrowing can be lowered gradually. One source estimated that a further pounds 3bn could be cut from the public sector borrowing requirement, if there was a return to 2 per cent growth while public expenditure was pegged to a rise of 1.5 per cent.

Treasury ministers are also keen to break the traditional pre- Budget purdah to go on to the offensive over the economy. John Smith, the Labour leader, is preparing a campaign against unemployment, due to break the 3 million mark next month. 'We can't afford to take a vow of silence this year,' one minister said.

Senior colleagues and the City reacted sceptically to the Prime Minister's initiative for a global alignment of currencies, described by some ministers as a second Bretton Woods - the 1944 conference that established the International Monetary Fund.

Gavyn Davies, chief UK economist at Goldman Sachs and another of the seven economists advising the Chancellor, said it was an 'implausible jump', and could forestall Britain's re-entry to the ERM.

'He was almost saying, 'I don't think this will happen and therefore we will stay out,' ' Mr Davies said.

Mr Major said: 'One of the problems we had in Europe generally over recent months was the disequilibrium between exchange rates and interest rates in Europe, and exchange rates and interest rates in the United States and

Japan.'

Underlining the need for the 'fault-lines' in the ERM to be corrected, Mr Major said Britain would not re-enter the ERM this year. He added: 'Now we may need to look - if we go back into the ERM and if the ERM is reconstituted in anything like its old form - at some form of relationship between the European currencies and the dollar and the yen.'

The Prime Minister's office said this had been raised with the European economic ministers reviewing the ERM after 'Black Wednesday' when Britain was forced out. Mr Major said it could be done 'informally by accords'.

Ruth Lea, of Mitsubishi Bank, said: 'The lesson of the last couple of years is that co-operation is unsuccessful. You begin to wonder if government will ever learn about foreign exchanges. You cannot beat them.'