Darling set to cut growth forecasts

City economists said they expected Darling to lower the Treasury's forecast of between 2.5% and 3% to as low as between 2% and 2.5% when he delivers his pre-Budget report next week.

But they warned this may not be enough as the impact of the world credit crunch hits growth in Britain.

George Buckley, of Deutsche Bank, is forecasting growth of just 1.8% next year - the same as in 2005 and the joint lowest level since 1992 when Britain was coming out of recession.

"Chancellors do tend to be more optimistic than the rest of us on economic growth," said Buckley, whose forecast is below the consensus in the City of 2.2%.

Philip Shaw, of Investec, said it was no surprise Darling will have to downgrade the forecasts Brown made in his final Budget as Chancellor in March.

"We were slightly surprised with the Treasury's optimism on growth for next year and recent events have really reinforced the downside risks to the economy," said Shaw.

However, ahead of the combined pre-budget report and three-year spending review expected on Monday, Mr Darling said he was "optimistic" overall about the state of the economy but warned the global credit squeeze would have "some effect" on the UK.

The lower growth rate will inevitably fuel speculation that borrowing will have to rise in order to avoid any electorally-damaging tax rises to fill the funding gap.

Mr Darling told the Financial Times: "If you look at the consensus of the economic forecasters, it would be prudent to assume that [the credit squeeze] will have some effect on us here."

The Chancellor was buoyant about his three-year public spending statement because it projects above-inflation growth, with generous settlements for health and education. He nevertheless delivered a fresh warning that public sector pay awards had to be kept under control to help fight inflation.

Darling on Northern Rock

Mr Darling also struck a hardline tone on the recent Northern Rock crisis, making clear that he rejected claims by Bank of England governor Mervyn King that the bank could have been rescued secretly in "smoke filled rooms".

He said lessons had to be learned and he would look at "boundaries" between the Treasury, the Bank of England and the Financial Services Authority.

Mr Darling said that Britain's economy was in a "very strong position" and was well placed to ride out the credit squeeze, but he said it was still bound to have an impact.

Speaking ahead of his pre-Budget statement to parliament, Mr Darling said he expected lenders to be more cautious in future, with a possible impact on the British housing market.

Mr Darling makes it clear that he will blame events far from the UK's shores for slower growth at home. "If you look across the world – given the importance of the US economy and given what's happened here in relation to the effect it will have on the availability of credit – it would be fairly odd if you didn't take account of that," he says.

Mr Darling hinted for the first time that he was concerned at the Financial Services Authority's failure to address Northern Rock's problems earlier. "Regulators have historically concentrated on solvency, for perfectly understandable reasons, but liquidity is also an important factor . . . specially in an institution like Northern Rock."

He will consider Mervyn King's view that the Bank was hamstrung by regulations in its efforts to intervene to support Northern Rock, he adds.

But he delivers a blunt put-down of the governor and his stated view that he would have preferred to rescue Northern Rock in a secret operation. "My view was it would be very difficult to do that in a covert way and I was pretty clear before the event that it would leak, and I was dead right – it did leak," he says pointedly.

Mr Darling goes on: "When people say that in the olden days you would have rounded up six people in a smoke-filled room and sorted it all out, well that depends on there being a willing purchaser and in this day and age – never mind the rules – I think the system is just far more open than it was."

There has been a constant ebb and flow of speculation in the last few days that Darling will on Monday next week give his first Pre-Budget Report - a mini-Budget - in which he trails some of the new taxes and spending laws that will appear in the full Budget next Spring.

The Pre-Budget Report is likely to be followed by the Comprehensive Spending Review, in which he sets out long term spending plans for the big Whitehall departments like education and health.

For details and a fuller explanation of the Budget and Pre-Budget Report, log-on to:
www.hm-treasury.gov.uk/budget