Early signs suggest Osborne’s gamble is not paying off

George Osborne’s ‘emergency budget’ was a huge gamble. He bet that the economy could absorb further tax increases, particularly an increase in VAT to 20 per cent, and swingeing cuts in public spending because private spending and exports would strengthen to fill gap. Unemployment might increase in the short-term, but eventually the private sector would create more than enough jobs to offset those lost in the public sector.

Unfortunately, the early signs are that he will be proved wrong.

The housing market has weakened in recent months and surveyors are now warning that prices will fall in the remainder of this year and again in 2011. Just about the last thing the economy needs over the medium-term is another house price bubble, but in the short-term falling prices can only hurt the economic outlook.

Business and consumer surveys suggest confidence is declining. It has not yet reached the point where it is sensible to talk of the UK being back in recession – but the trend is clearly in the wrong direction for those hoping that a strong recovery in private spending will boost the economy.

Price inflation looks set to remain well above its target level – and, crucially, well above wage inflation – for at least another year. As a consequence, households’ spending power will be eroded, dampening any recovery in consumer spending.

And the much-anticipated surge in exports has yet to materialise. True, figures released today did show that export volumes of goods in the second quarter were up 11.7 per cent compared to a year earlier. But import volumes were up 12.8 per cent over the same period. Global trade was depressed a year ago by the scale of the recession and now it is returning to more normal levels, hence the large increases. But there is nothing to suggest that the UK is performing relatively strongly.

This is also evident in the overall trade balance in goods and services, which in the second quarter of 2010 was not far short of the levels seen in 2007 – just ahead of the recession.

The Office for Budget Responsibility expects net trade (the difference between export and import volumes) to add 3.5 per cent to output growth in the UK over the next five years – an average of 0.7 per cent a year and equivalent to over one-quarter of the UK’s growth. Worryingly, there is nothing in the latest data to suggest that this is likely to materialise.