Yesterday's shocking figures for GDP in the last quarter of 2010 – showing a contraction of 0.5% (or 0% if the bad weather effects are stripped out) – have changed the dynamics of British politics. As most of the newspapers make clear today, these numbers have shaken the confidence of the Coalition and raised the stakes over its chosen deficit reduction strategy. If the economic outlook worsens – and Ed Balls was careful not to predict a double-dip recession yesterday – the Coalition's big arguments about the deficit will be seriously undermined. Labour will make up lost political ground and, as one senior Labour figure put it to me yesterday, Ed Balls may end up looking like Churchill.
We can more certainly predict a couple of things. First, it is now inevitable that growth will be the major theme of the Budget and that it will contain a fistful of measures to cut business taxes and regulations, on the one hand, and to boost public spending in pro-growth areas like infrastructure, the regional growth fund and so on. Osborne will have some scope for both, despite the weak output figures – although the Treasury will play down this headroom. If he has any sense, the Chancellor will repair some of the damage to cuts in housing spending: construction employs lots of labour, we need more homes, and the industry shrunk by 3.3% in the last quarter of 2010.
We can also be sure that Mervyn King is right when he says that living standards will be viciously squeezed this year. Inflation is rising and wages are falling. He was correct to point out that the fall in real wages has taken place over a nunber of years – and was a major contributor to Labour's defeat in 2010 – and that the situation is unprecedented since the 1920s.
On this score, however, Osborne has less room for maneouvre, since his tax and spending plans take great chunks out of household budgets, as my former colleague Gavin Kelly graphically illustrated in the New Statesman earlier this year. The so-called 'squeezed middle' debate has only just begun and now sits at the heart of the politics of stagflation.
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