As expected, the Treasury has slashed its Budget forecasts for economic growth. It now expects growth to be just 0.75% in 2008 and it then predicts that the economy will shrink by around 0.75-1.25% in real terms in 2009, broadly in line with the latest independent forecasts. The Treasury still takes a relatively optimistic view of medium-term prospects, however, projecting that GDP growth will rebound to 1.5-2% in 2010 and an average of 3% per annum in the following three years.

Public sector net borrowing is now expected by the Treasury to be around £78 billion in 2008/9 and £118 billion in 2009/10, way above its Budget forecasts due to the effects of the recession and the fiscal stimulus measures announced in the PBR. The latter are estimated to cost a net £20 billion in 2008/9 and 2009/10.

The Treasury expects that economic growth will bounce back quickly from 2010/11 onwards, boosting tax revenues and returning public borrowing in 2013/14 to a more sustainable level of around £54 billion (2.9% of GDP). This is possible, but the economic risks are weighted to the downside at present given the uncertain impact of the global financial crisis.

The Treasury forecasts that net public debt will rise to around 57.4% of GDP in 2013/14, excluding the effect of Northern Rock and other recent financial sector interventions. The Chancellor has therefore abandoned his old 40% debt limit and also does not expect the Golden Rule to be met again until around 2015/16. This is a long time to wait and the risk is that financial market worries about this rise in public debt (to around £1 trillion by March 2013) could lead to higher long-term UK gilt yields in the medium term.

The Treasury forecasts that total public sector revenues will drop from 38.5% of GDP last year to a low of 36.2% of GDP in 2009/10. But this downward trend in tax revenues is assumed to be reversed in later years due to a combination of economic recovery, fiscal drag and discretionary tax rises focused on high earners. By 2013/14, tax revenues are projected to rebound to 38.6% of GDP, similar to 2007/8 levels.

Public spending is expected to be above budgeted levels in the short term, but is now assumed to grow significantly more slowly than the economy at an average real rate of just 1.2% per annum between 2011/12 and 2013/14. But we consider that even tighter spending growth, or additional tax rises, may well be needed to restore the public finances to health in the medium term. This will certainly be a long and painful process.