The deficit is down but we are still lying on a bed of nitroglycerin

Chencellor George Osborne plans to eliminate the deficit by 2018

In ordinary circumstances, George Osborne’s latest borrowing figures would be greeted with utter horror by City scribblers. If economists had been told in 2005 that a decade hence the government would be forced to borrow £10.1bn in a month, their reaction would have been a combination of disbelief, bafflement and horror.

Such a shortfall would have been unimaginable in establishment circles just a few years ago, when it seemed as if no Western economy would face an economic crisis ever again. And how could such a massive shortfall not trigger an immediate Armageddon, sterling crisis and bond market crash?

• Good news for George Osborne as borrowing drops to eight-year low in May

But these are not ordinary times. The May borrowing figures were actually positive for George Osborne. The deficit was £2.2bn lower than last year and £0.2bn below market expectations; indeed it was the lowest May borrowing number since 2007. We are still borrowing a horrendous amount — 5pc of GDP in the most recent fiscal year — but we have come a long way since the 10.2pc of GDP deficit seen in 2009-10, a truly shocking outcome.

Central government receipts grew by 4.1pc in May as the tax base improved with the economy; VAT receipts rose by 5.6pc. Central government current expenditures were up 0.6pc, while net investment was down 8.7pc. These latter figures on spending are especially volatile and not too much should be read into them, which is fortunate given that spending cuts need to be focused on current expenditure, not capital spending.

It is quite possible, if these trends continue, that Osborne could meet or even improve on his deficit reduction forecasts for this year. The deficit was £89.2bn in 2014-15, £9.3bn lower than 2013-14; the Treasury hopes that it will fall to £75.3bn this year and finally go into surplus in 2018-19.

This would require borrowing to be slashed by £13.9bn this financial year; so far, two months in, around £5.1bn has been shaved off. The figures tend to be revised up over time, unfortunately, but the trend is looking good, if not fantastic.

The news in other areas is pretty decent also. Inflation is stable: the consumer price index moved from a drop of -0.1pc in April to +0.1pc in May, confirming that we are not on the brink of a deflationary collapse in prices. Real wages rose by 2.7pc in real terms over the past year, a strong performance.

The real worry is what happens to growth and the deficit when interest rates start to go up. With real wages improving so markedly, this moment is moving closer, though the Bank’s monetary policy committee will probably keep its powder dry until the Federal Reserve begins to raise its own interest rates.

The problem for the UK is that while our recovery is real, and some genuine fiscal tightening has taken place, many weaknesses remain; and nobody really knows for sure how consumers and businesses will respond to being weaned off from the drug of easy money. The current account deficit is huge; house prices are horrendously inflated, especially in London and the home counties; the gilts market remains astonishingly favourable to the government, with massive demand for what by historical standards remains low yielding securities; the pound has shot up, hitting exporters; and productivity growth remains abysmal. We continue to be propped up by relatively low oil prices, even if they are much higher than they were. Rates should have risen modestly a while back, to help the economy readjust to more normal conditions; when the monetary tightening does eventually take place, it will come as a shock.

To paraphrase a claim that became infamous five years ago, we shall soon find out whether the UK is still lying on a bed of nitroglycerin — or whether, somewhat miraculously, our ills have actually been cured.


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