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REALITY CHECK AS UK DEFICIT SOARS

TENTATIVE signs of a recovery in the UK economy were dramatically overshadowed yesterday when credit ratings agency S&amp;P downgraded its outlook on UK debt and the scale of the crisis in the public finances was laid bare.<br /><br />S&amp;P lowered its outlook on the UK&rsquo;s prized AAA credit rating to &ldquo;negative&rdquo; from &ldquo;stable&rdquo;, giving a one in three chance of an actual downgrade. Such a cut would push up the cost of borrowing for the government, ultimately resulting in higher taxes and borrowing costs for the private sector.<br /><br />The damaging decision came minutes ahead of the publication of public finance data for April, typically the UK&rsquo;s strongest month, showing public sector net borrowing reached &pound;8.5bn in April &ndash; the highest deficit for the month on record. Public sector net debt is now 53.2 per cent of GDP, up from 35.6 per cent two years ago &ndash; and at its highest level since 1975-6 just before the UK had to be bailed out by the IMF to the tune of &pound;2.3bn. Central government revenues have plunged 10.2 per cent year on year in the past three months to April, while government spending has rocketed by 5.3 per cent.<br /><br />Other official data added to the gloom. Business investment fell 6.8 per cent year on year in the first quarter to &pound;33bn &ndash; its sharpest plunge since 1992 &ndash; as private sector businesses scaled back their capital spending.<br /><br />Meanwhile, Bank of England figures showed that total bank lending fell 0.2 per cent month on month in April &ndash; the first drop since data began in 1982, though the figures may have been distorted. And the Council of Mortgage Lenders (CML) sought to play down recent suggestions that the housing market is on the verge of recovery, revealing the amount lent by its members stood at &pound;10.4bn, down from &pound;11.4bn in March and 60 per cent lower than in April last year.<br /><br />Amid the gloom, however, better than expected retail sales from the Office for National Statistics provided one positive note with sales up 2.6 per cent in April compared with a year ago and 0.9 per cent compared with March, prompting optimism that the worst of the recession has passed for retailers. The numbers add support to the most recent PMI survey by CIPS/Markit showing activity in the services sector, which accounts for three-quarters of Britain&rsquo;s economy, shrank at its slowest pace since last August. In April, the headline activity index saw its biggest one-month rise in a decade.<br /><br />But economists yesterday cautioned that any signs of economic recovery would be hampered by the increasing cost to Britain of financing its national debt, forcing the government to hike taxes and cut public spending just as the economy begins to recover.<br /><br />&ldquo;Whoever wins the next election, tax hikes and sharp spending cuts will be the order of the day, but today&rsquo;s announcement by S&amp;P puts that much more pressure on the next government to act quickly,&rdquo; said Colin Ellis, economist at Daiwa Securities.<br /><br />The FTSE 100 plunged 2.8 per cent to 4,345.47 yesterday, and the pound fell.