Brown's holding operation

NO, YOU did not miss anything important while you put the kettle on - the Budget really was that dull.

There was the usual plethora of minute adjustments aimed at improving the economy's supply-side performance and clamping down on tax avoidance, but major policy announcements were noticeably thin on the ground.

No single measure was worth more than £500m a year and, all-in-all, the net effect of the changes will be to cost the Chancellor an almost negligible £725m in 2004-05.

But this Budget was always likely to be something of a holding operation given the recent sharply conflicting news on the economic background and the state of the public finances.

The good news is that the economy has started to show signs of life after three years of sluggishness. Thanks both to a pick-up in the global economy, led by the US, and the astonishing resilience of the British consumer, gross domestic product growth has accelerated rapidly in the last few quarters.

What's more, there is enough momentum to ensure that the economy will probably meet the Chancellor's forecast of between 3% and 3.5% GDP growth in 2004.

Little wonder, then, that he allowed himself a swipe at those who had previously expressed doubts over whether such rapid growth could be achieved.

But while the economic recovery has saved Mr Brown from having to take immediate action to improve the public finances, he is hardly in a position to splash money around either.

Today's Budget was the first in a while in which he has not been forced to raise his forecasts for public borrowing significantly, but they still show borrowing at alarmingly high levels over the next few years.

The result is that, while the Chancellor expects to meet his own Golden Rule - which states that the Government must only borrow to invest over the economic cycle - he expects to do so by a margin of just £11bn. That might sound like a comfortable cushion but once you consider that the Treasury's average forecasting error for borrowing two years ahead (when the cycle is expected to end) is close to £20bn, it is clear that the Chancellor's elbow room is wafer-thin.

Against this backdrop then, Mr Brown had little choice today but to sit on his hands and hope for two things. First, that the economic recovery seen in recent months continues over the next year and beyond. And second, that the public finances soon start to respond favourably to the recovery.

As far as the first hope is concerned, while the economy has a decent amount of momentum, there are major doubts over whether it can continue to expand at a rate of between 3% and 3.5% next year too, as the Chancellor is relying on. Perhaps the most obvious threat is a sharp slowdown in the overheated housing market, with negative effects on borrowing and spending.

However, another danger is the recent strength of the pound on the foreign exchanges which, if it continues, could hinder the anticipated recovery in net trade and investment.

Even if the Chancellor is right about the economy - and recent experience suggests that it might be foolish to bet too strongly against him - this does not necessarily mean that public borrowing will fall back in the way he is hoping.

In the fiscal year 2003-04, for example, it looks as if the economy will actually have outpaced the forecast for growth published in last April's Budget. Yet public borrowing this year looks set to come in some £10bn higher than the Chancellor expected, at about £37bn.

The message is very clear - you can get the economy right but still get the public finances horribly wrong! The upshot is that, in not raising taxes today, Mr Brown may simply have put off the inevitable.

If the economy slows even moderately over the next two years or if the relationship between the public finances and the economy continues to disappoint, sizeable tax increases will eventually be required to meet the Golden Rule.

Of course, the Chancellor will do his best to ensure that these come the other side of the general election in 2005 or 2006. The fiscal rules are, to some extent, fudgeable, not least when it comes to the precise definition of the economic cycle.

But ultimately, it seems likely that whoever is resident at No. 11 Downing Street will have to take decisive action to bring the public finances back into a satisfactory position early in the next Parliament. No doubt Mr Brown will be hoping to observe events from next door.

Jonathan Loynes is chief UK economist of Capital Economics