Timing the key as Darling's twin tasks become a juggling act

On the one hand, he needs to produce a clear plan to get the public finances back on track. Yet in doing this, he must be careful not to derail a recovery that is in its early stages and remains fragile and prone to relapse.

The UK's fiscal reputation is on notice. Already Standard & Poor's and Fitch have warned that the UK could lose its AAA status because of the spiralling public sector debt, and the Chancellor needs to demonstrate a clear strategy for remedying this.

But timing is crucial - reining in fiscal policy before the recovery has moved on to a firm footing risks tipping the economy back into recession. The example of Japan in the 1990s, where premature and overly aggressive fiscal tightening pulled the economy into a double-dip recession and the infamous "lost decade", should serve as a stark warning to the Chancellor of the risks of applying the squeeze too soon.

Officially, the UK economy remains in recession, the only country in the G20 in this unenviable position. Yet it is also the only country planning to begin withdrawing its stimulus at the start of 2010; most other governments plan to continue supporting their economies next year. Withdrawing the fiscal stimulus this early represents a huge risk, even more so given that there is no room to loosen monetary policy to offset the negative effects of tighter fiscal policy.

We would like to see the Chancellor announce a temporary extension to those measures - such as the VAT reduction, stamp duty holiday, car scrappage scheme and first-year capital allowances - which are already in place to provide support but which are due to expire soon. With smaller companies still finding it difficult to access finance we would also hope to see some targeted help for them.

Providing that such a package were accompanied by a clear commitment to reverse them as soon as the recovery has become entrenched, it would not have a significant impact on the efforts to regain control over the public finances.

As well as securing the recovery in the short term, we hope to see the Chancellor use the Pre-Budget Report as an opportunity to set out his vision for putting the public finances on a more sustainable footing over the medium term. After all, we are running the largest deficits in the developed world and without further remedial action a credit downgrade is a serious risk.

The new Fiscal Responsibility Bill commits the Government to halving the deficit within four years. We know from the Budget that the Chancellor intends to achieve this through a combination of deep spending cuts and tax rises for the rich.

However, his plans were based upon some very rosy assumptions for the pace of the recovery - his forecast for 2009 alone will need to be downgraded by at least 1% - and some optimistic forecasts about the recovery in tax revenues. There has been a long history of fiscal deficits overshooting the Treasury's forecasts and, on current policy, this is likely to continue. Our forecasts, using the Treasury model, suggest that a further £15 billion of fiscal tightening over-and-above that already announced will be needed to meet the terms of the Fiscal Responsibility Bill.

In terms of how the Chancellor should go about tightening policy he appears to be on the right track - history suggests that spending cuts are more likely to reduce debt while also having a limited impact on economic growth. But it is going to be very difficult to find the extra £15 billion from spending cuts alone so further tax rises are a certainty. However, given political considerations we would expect the Chancellor to leave this discussion for another day. We will, however, be looking for Mr Darling to put more flesh onto the bones of the proposed spending cuts.

There has been much talk about the need to make deep cuts and commitments to protect front-line services, but very little detail in terms of where the cuts will actually occur. Publishing a clear, unambiguous plan for cutting spending would add credibility to the Chancellor's policies and go a little way toward placating the ratings agencies - although this will not prevent the need for further tightening from whichever party is in power after the election.

Tomorrow's Pre-Budget Report will be a landmark in the run-up to the spring election. The Chancellor has two key tasks to perform - to provide sufficient support to the economy to ensure recovery in the short-term and to come up with a more comprehensive plan to fix the public finances. Neither is an easy task and we await his speech with great interest.