Last updated: May 17, 2010 10:36 pm

Treasury ‘skeletons’ give sterling a fright

David Laws and George Osborne©AFP

Serious outlook: David Laws, left, chief secretary to the Treasury, and George Osborne, chancellor of the exchequer

Financial market fears about the state of Britain’s public finances were highlighted on Monday when sterling briefly tumbled after the new coalition government accused its Labour predecessors of “fixing” fiscal forecasts.

Chancellor George Osborne’s comments in a Financial Times interview about finding “various skeletons in cupboards” and the “irresponsibility” of the previous government spooked the markets, which have been particularly jumpy about the accuracy of public finances since Greece massively restated its budget deficit last year.

Investor reaction underscored how the political temptation to blame Britain’s fiscal problems on the previous administration risks provoking turmoil in the financial markets.

“Until we know how bad ‘bad’ is, the markets will remain nervous,” said Derek Halpenny, European head of global currency research at Bank of Tokyo-Mitsubishi UFJ.

At a press conference, Mr Osborne criticised Labour’s budgetary profligacy saying he would hold an emergency Budget on June 22 and detail the first £6bn of coming public spending cuts next Monday.

He also announced the creation of a budgetary watchdog – the Office for Budget Responsibility – to provide independent economic and borrowing forecasts for the government.

Former Labour ministers were furious that they were being blamed for the tough spending decisions to come over the next few weeks. “The suggestion that Treasury civil servants have colluded in publishing anything other than accurate figures is just plain wrong,” said Alistair Darling, the former chancellor.

But Labour Treasury ministers did themselves no favours in the public relations battle as David Laws, the Liberal Democrat chief secretary to the Treasury, revealed that Liam Byrne, his predecessor, had left him a stark letter of advice saying there was no money left.

The pound slumped by 1.9 per cent against the dollar to reach a 14-month low of $1.4249. But it later rallied in line with the euro as the global session progressed, to trade down 0.5 per cent at $1.4408.

Gilts also took a hit on fears that the government would have to issue more debt than originally thought to fund its deficit. The yields on 10-year benchmark notes rose 6 basis points to 3.79 per cent at one stage, before closing flat on the day at 3.73 per cent.

“Until we know how bad ‘bad’ is, the markets will remain nervous,” said Derek Halpenny, European head of global currency research at Bank of Tokyo-Mitsubishi UFJ.

However, economists welcomed the establishment of the OBR, which has the power to set government economic and borrowing forecasts.

Michael Saunders, of Citigroup, said: “This can’t be a substitute for action [on the deficit] but it is a very important long-term step.”

Jonathan Loynes, of Capital Economics, said it was likely the OBR would provide weaker forecasts for growth and the public finances before the emergency Budget in June, which would “point to the need for additional tax increases building up to around £50bn per annum to bring borrowing down in line with the new government’s plans”.

The seriousness of the fiscal situation was underlined by Sir Alan Budd, interim OBR chairman. “The problems of fiscal policy are much more challenging than the problems of the control of inflation in 1997,” he said.

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