Brussels tells Brown to raise taxes or cut spending

The International Monetary Fund and the European commission called on Gordon Brown yesterday to increase taxes or reduce spending as both organisations separately slashed their forecasts for British growth this year.

In Washington, the IMF said the chancellor would need to tighten fiscal policy by about £10bn - adding roughly 3p to the standard rate of income tax - to meet his own fiscal rules. The IMF said that it now expected the British economy to grow by just 1.9% in 2005, 0.7 points lower than it forecast in the spring, and far below Mr Brown's budget prediction of 3%-3.5%.

It said that Britain was running a structural deficit of more than 3% of GDP, and that action was required. David Robinson, an IMF economist, said that while the fund believed that Mr Brown had managed the public finances well, there was broad concern about the outlook. "We have argued that there is a need for a gradual and modest fiscal consolidation of 1% of GDP to ensure the fiscal rules are met."

In April, in the run-up to the election, the chancellor rebuked the IMF over its view of Britain's economy and insisted the fund should raise its forecasts. But the IMF said yesterday that the weakening housing market and the rise in oil prices meant Britain would grow more slowly. It also lowered its forecast of growth next year from 2.6% to 2.2%. "Higher oil prices and weaker euro-area growth remain key downside risks," the IMF said.

The warning coincided with a broadside from Brussels over the UK budget deficit. The commission is launching an "excessive deficit procedure" against Britain because the deficit was likely to exceed its limit of 3% of GDP for the second year running.

Subdued growth and slack consumer demand could keep the deficit above the limit for another two years at least, it said, adding that Mr Brown's expectations that the deficit would shrink this year and next were implausible. It cut its growth forecasts for the UK economy to 2.1% this year, down from the 2.8% predicted in the spring, and only "possibly slightly higher" next year. It too blamed weaker consumer spending and the weak housing market.

The commission does not have the power to fine Britain for the excessive deficit because it is not in the euro but the ticking off is an embarrassment for Mr Brown, especially as Britain holds the rotating EU presidency. The Treasury said Britain's deficit was "extremely small" and that the economy was in good shape.

But the Tories jumped on the reports, calling them a blow to Mr Brown's reputation. "This double whammy is bad news for Britain. And worse still, most independent economists think that taxes will have to rise to balance the books," said the shadow chancellor, George Osborne.

Minutes of the latest meeting of the Bank of England monetary policy committee showed that the nine-member body voted unanimously this month to leave interest rates steady at 4.5%, a month after cutting them by a quarter point for the first time in two years.