Budget 2011: inflation and debt figures back Osborne's case - The Guardian

It's the eve of the budget. You are George Osborne sitting in the Treasury when the news comes in that inflation in February is up to 4.4% and the public finances are in the red by a stonking £10bn-plus.

Bad news for the chancellor? Yes and no. Clearly, there are massive downside risks for the government stemming from the current state of the economy. Output is weak yet prices are rising. Unemployment is on the up and consumer confidence is on the floor. People are paying more for fuel, domestic power, food and clothing but are not seeing their pay go up to anything like the same extent. Real incomes are falling, a trend that historically has spelt trouble for those wielding political power.

Similarly, the state of the public finances with 11 months of the financial year gone highlight the challenge faced by Osborne in reducing the UK's colossal budget deficit. Following the encouraging January figures, there was hope that the total for the full year would come in substantially below the £148bn forecast by the Office for Budget Responsibility last year. Some optimists talked of a £10bn undershoot. That now looks highly improbable following news that last month's deficit was unsurpassed since modern records began 18 years ago.

The silver lining for Osborne is that both the inflation figures and the borrowing data provide cover for a steady-as-she-goes budget on Wednesday, which is what the chancellor always wanted to deliver. Had the borrowing figures again been far better than expected, there would have been pressure on the Treasury to ease up on the austerity measures planned for the coming years. One of Osborne's criticisms of the last Labour government is that it tended to overestimate tax receipts, so he was never likely to be seduced by calls for a giveaway. But Tuesday's public finances give him perfect cover for a neutral package that neither pumps money into the economy nor removes demand.

The same applies to the inflation numbers. Osborne and his aides argue that it would be counter-productive to ease fiscal policy because the inevitable outcome would be higher interest rates from the Bank of England. Threadneedle Street is already fretting about the steady increase in the cost of living over the past year and the news that the CPI measure of the cost of living has hit 4.4% and the RPI measure 5.5% will have done little to assuage the concerns of the Bank's growing number of hawks. The chancellor believes that if he indulged in any budget generosity the benefits would be clawed back by an early increase in the cost of borrowing which would hobble attempts to rebalance the economy towards manufacturing and exports.

Osborne will have been boosted by today's CBI monthly snapshot of manufacturing that this process is now under way. One of the few bright spots recently has been the pick up in industrial output, which has fed through – via a lower exchange rate – into higher exports. The chancellor has no wish to see this process truncated by higher interest rates, which would probably result in a higher level for the pound.

All this, of course, presupposes that Osborne's judgement is right. If – and it is a very big if – the economy can really withstand the toughest bout of sustained fiscal tightening since the 1920s, the chancellor will get credit for sticking to his guns, even in the face of poor economic data. The alternative explanation is that the chancellor has got it spectacularly wrong. There is, on this interpretation, no gloss that can be put on Tuesday's figures, because they add weight to the evidence that the UK is mired in a low-level stagflation that is about to be intensified by spending cuts and – quite possibly – higher interest rates as well.