By David Milliken
LONDON, Nov 21 (Reuters) - Financial markets want a clear time-limit for any tax cuts or extra spending pledges in Britain's pre-budget report on Monday.
British Prime Minister Gordon Brown has been saying for weeks that higher government borrowing to support the economy is the best way to brace Britain against a sharp slowdown.
Economists expect any stimulus package to inject at least 15 billion pounds ($22.25 billion) into the economy, in line with a likely European Commission call for stimulus equivalent to 1 percent of GDP. The IMF has called for 2 percent.
But the government will have to present clear plans for how it will rein back spending or raise taxes once the worst of the crisis is over, or sterling risks weakening further and the interest it pays on new debt may rise.
"A large fiscal expansion that is not accompanied by a robust and credible framework for medium term fiscal discipline can get a punishing response from the markets. The risk premia on UK assets could widen, yields jump higher and sterling depreciates sharply," said Amit Kara, an economist at UBS.
The economic slowdown and existing government finance pledges mean the IMF forecasts that Britain will run a budget deficit of over 3 percent this year and over 4 percent in 2009, more than any G7 country apart from the United States.
Demand at government gilt auctions has sagged in recent months as borrowing racks up to fund the recapitalisation of high-street banks, and sterling has fallen by almost a quarter on a trade-weighted basis <=GBP> since the start of the year.
GETTING AWAY WITH IT?
But some bond strategists believe the British government may well be able to avoid a hammering from markets.
"The government may get away with it and snatch victory out of the jaws of defeat," said Richard McGuire, a fixed income strategist at RBC.
"In outright terms we think we'll remain for much of next year in a bull market for bond markets internationally and for gilts -- cyclical considerations will dominate supply," he said.
Strategists expect gilt sales to rise to around 130-140 billion pounds this fiscal year, a record level equivalent to nearly 10 percent of GDP and far above the net 38 billion the government had forecast.
Yet past experience suggests that governments can raise borrowing in a downturn, and the weak economy -- which boosts demand for gilts -- will outweigh the negative impact of increased supply.
In the 1993-94 fiscal year, net issuance rose to 6.6 percent of GDP but yields, which drive the cost of new financing, fell.
Then as now, inflation and interest rates were falling.
As for sterling, Philip Shaw, an economist at Investec, reckoned that most of the bad news had been priced into the pound, which is trading at a record low against the euro.
Nonetheless, McGuire said the government may be storing up trouble for the future as even when the British economy recovers, past big revenues sources such as property transaction tax, the financial sector and oil industry are unlikely to return to their former strength.
Morgan Stanley also argued greater gilts issuance would not necessarily push up yields as demand from investors was rising during the economic downturn as they sought safer investments.
Nonetheless, economists stressed that this relatively rosy prospect for the British government hinged on it being able to persuade investors that Monday's plans were a one-off that would succeed in taking some of the sting out of a looming recession.
"Amid concerns of runaway borrowing in the UK and its potential effect on sterling, the government has a fine line to tread," said Matthew Sharratt, an economist at Bank of America.
"Any short-term fiscal stimulus needs to be balanced with a convincing plan to reduce levels of borrowing in coming years." For a preview of the pre-budget report, click on [ID:nLJ507689]
For a factbox on what's expected in the package, click on [ID:nLK741772]