UK Budget: Strong and stable, the search is now on for sustainability (page 1 of 2)

Strong and stable. But is it sustainable? This is the key issue facing the UK economy after UK Finance Minister, Chancellor Gordon Brown delivered his eight annual Budget in mid-March. It was a significant event in a number of ways.

First, it highlighted how well the UK economy is doing. Indeed, The UK is growing at a rapid pace and has been one of the star performers of the world economy in recent years, outperforming other industrialised countries. Sterling is strong and UK assets are seen as attractive. A positive feature for the UK has been its macro-economic stability, helped by a credible policy setting framework. One needs only make a comparison with the European Union to see how well the UK is doing.

Second, the Budget effectively signaled the start of the next general election campaign. Even though the election need not be held for two years, it is widely expected to occur in May or June next year.

Third, the Budget showed that the fiscal numbers on government spending and tax are credible, but only if the economy continues to grow at a strong pace. That is certainly likely this year, but in future years it is far from clear.

The immediate market impact of this Budget was limited. There were few surprises, with the overall fiscal stance broadly neutral. The Chancellor added a relatively small 725 million GBP to the economy this fiscal year, and is taking out an even smaller 65 million GBP next year. These are tiny sums for a Chancellor who previously has shown a strong desire to interfere, with countless tax measures.

A fiscally neutral Budget points to the Bank of England having to fine tune the economy with further, albeit small, interest rate increases. This makes life tough for the Bank of England, as inflation is low but asset prices and borrowing continue to rise strongly. Any rises in interest rates could push sterling even stronger, despite the problems this is already causing for UK exporters.

The Chancellor's first four Budgets, from 1997 to 2000, were dominated by prudence. The Chancellor then played to the markets, keeping public spending under control. In this Budget the focus was on securing long-term stability, with fairness in tax and attempts to encourage enterprises. Yet, by his previous standards, the Chancellor did little, keeping financial markets content. Perhaps more importantly from a political perspective, he avoided alienating business, whilst he kept voters content by avoiding tax increases and pointing to further significant spending rises.

The UK's present economic picture appears good. After 2.3% growth last year, as expected the Chancellor retained his growth forecasts of between 3% and 3.5% for both this year and next. "A Britain of stability and strength" was the message. Yet, for strong growth to be sustained requires growth to become more balanced. And that, in turn, requires, a better mix with higher investment and an improved trade performance. In recent years, the two areas of the economy that have been growing strongly have been driven by debt: consumer debt and government debt. Yet financing such debt is not proving a problem for either consumers or the government.

Strong jobs and steady income growth has given people the confidence to take on more debt. And low inflation leading to low interest rates has made it cheap to service such debt. The ideal situation would be a gentle slowdown in consumer spending, matched by both a rise in investment and a trade improvement. Yet, despite the Chancellor's upbeat assessment of the economy, businesses seem more cautious.