Budget 2011: Government 'due £8bn windfall'

The government appears to be gaining control of the public finances and could benefit from an £8bn windfall this year due to higher tax revenue and lower spending, a report suggests.

The Ernst & Young Item Club forecast public borrowing for the year to the end of March to be lower than expected.

But it argued that the government should not water down its planned spending cuts.

It also said risks to the economic recovery had grown in recent months.

Fuel duty

The club said it expected public sector borrowing for the financial year to come in at £140.2bn, compared with the £148.5bn forecast by the Office of Budget Responsibility.

"So far, the fiscal plan is on track, which is good news for the chancellor [George Osborne]," said Andrew Goodwin, senior economic advisor to the Item Club.

"But the Treasury needs to resist the temptation to utilise the windfall to provide a little sweetener to the bitter pill of fiscal retrenchment - it is still very early days on the long and challenging road to fiscal balance."

For this reason, the Item Club said it expected Wednesday's Budget to be "relatively light" on major policy announcements.

However, it did say that the rise in fuel duty due to come in this April could be scrapped.

"While scrapping the rise in fuel duty would reduce the planned £1.6bn in additional tax take from this source, this would be partly offset by the fact that higher oil prices will mean stronger corporation tax receipts from North Sea oil companies," said Mr Goodwin.

Spending cuts

On Sunday, Mr Osborne told the BBC it would be "a huge mistake" for the government to water down its spending cuts.

He said the proposed cuts, designed to reduce the government's budget deficit, had already helped to "rescue" the UK economy.

The Item Club said it expected Mr Osborne to meet his target of eliminating the budget deficit over the next four years.

The government's spending cuts, due to be made later this year, have ignited great debate among economists and politicians.

Shadow chancellor Ed Balls has accused the coalition of "recklessness" by making such stringent cuts at a time when the economic recovery remains fragile.

The UK economy contracted by 0.6% in the final three months of last year.

The government argues that without sweeping cuts, international investors would start to lose faith in the UK's ability to repay its debts, which would increase the government's cost of borrowing.

Rate rise

Despite cautioning against watering down the spending cuts, the Item Club warned that the risks to economic growth had increased in recent months.

This was in part due to a "surge" in commodity prices, particularly oil, which is causing higher inflation, it said.

This in turn could lead to higher interest rates, both in the UK and abroad, which could "potentially dampen growth" by hitting consumer spending.

There have been growing calls for the Bank of England to raise rates to combat inflation, which is currently running at 4% as measured by the consumer price index - double the Bank's target rate.

The Bank has so far resisted these calls, arguing that a rate rise could jeopardise the recovery.