Britain's newly created budget watchdog downgraded economic growth forecasts on Monday but did not radically alter the scale of austerity measures required from the country's coalition government.

Britain's economy will grow more slowly after this year than the previous Labour government expected but state borrowing will fall a bit faster than originally thought partly due to recent higher tax receipts, the Office for Budget Responsibility said.

Moreover, changes in the assumptions underlying the forecasts limited the impact of the growth downgrade on the public finances, and led both Conservative finance minister George Osborne and his Labour predecessor Alistair Darling to argue that the forecasts vindicated their policies.

Osborne said the forecasts reinforced the need for major fiscal tightening in the new Conservative-Liberal Democrat coalition's emergency budget on June 22, and blamed Labour for leaving behind an even bigger fiscal mess than expected.

But Darling said the forecasts showed public borrowing was on track to fall to acceptable levels without more fiscal tightening than planned by Labour, and said extra Conservative spending cuts could push Britain into Japanese-style stagnation.

Britain has a record budget deficit, running close to 11 percent of gross domestic product, and the coalition is under pressure to reassure markets it will slash borrowing given fears of contagion from the euro zone fiscal crisis.

The OBR, created shortly after the coalition took office last month, said the economy should grow 1.3 percent this year, in line with previous forecasts, but growth would only rise to 2.6 percent in 2011.

Labour, which had been accused of adopting an overly optimistic outlook, had expected the economy to grow between 3 and 3.5 percent next year. The OBR also penciled in slower growth than Labour for the years ahead.

The weaker growth forecasts had a limited impact on headline borrowing forecasts because the OBR made different assumptions about interest rates than the finance ministry did before the March budget.

The OBR also changed the practice in Labour borrowing forecasts of assuming that growth would turn out worse than predicted. Instead it used its central growth forecast for borrowing estimates, leaving it to government to build in a safety-margin.

Nonetheless, the OBR stressed the uncertainty surrounding any economic forecasts. All ... forecasts will be wrong, though some will be more wrong than others, said the head of the OBR, former finance ministry official and central bank policymaker Alan Budd. It's our best shot at an impossible task.

The OBR, which uses its new central forecast for growth rather than more pessimistic estimates used in the March 2010 budget, expects public sector net borrowing to fall slightly faster than predicted in Labour's last budget.


Sterling rose against the euro and the dollar and British government bonds trimmed losses after the overall downward forecast to the UK debt burden.

Markets, rattled by the euro zone fiscal crisis, are on alert for any sign that borrowing levels are getting out of control. But analysts were more sanguine.

There are really no big obvious surprises. The growth numbers were expected to be revised down and the public finance numbers have been coming out better than expected, said Amit Kara, an economist at UBS.

We have to understand that the OBR is really just another forecasting body and its forecasts are just as vulnerable to being right or wrong as any other respected body.

Public sector net borrowing is expected to come in at 155 billion pounds ($227 billion) -- or 10.5 percent of national output -- in the fiscal year 2010/11, compared with previous forecasts for 163 billion pounds.

By the end of this parliament in 2014/15, that ratio is seen falling to 3.9 percent -- slightly lower than the 4 percent predicted in March.

However, Osborne argued borrowing would have been higher if the OBR had used the same forecasting method as the finance ministry had used in March, and also if market interest rate expectations had not fallen in anticipation of extra fiscal tightening by the new government.

Moreover, he said the coalition would use the structural budget deficit -- which strips out the effect of the business cycle on government borrowing -- to determine fiscal tightening.

Based on this measure, the budget deficit will fall more slowly than forecast in March.

The OBR said annual cyclically adjusted net borrowing would fall to 2.8 percent of GDP by 2014/15 from 8.8 percent of GDP in 2009/10, compared to a drop to 2.3 percent from 8.4 percent in March's budget.

Though this measure -- unlike that for PSNB -- paints a bleaker picture than in March, some economists argued that the difference was nonetheless minor compared to the overall scale of British government borrowing.

The Chancellor (finance minister George Osborne) ... is facing a very similar outlook to the picture in the March budget, said George Buckley, an economist at Deutsche Bank.

The structural deficit is slightly worse, so they might have to do a bit more than they would have had to in terms of the structural adjustment.

(Editing by Ruth Pitchford, Ron Askew)