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Osborne tries to sweeten pill for austerity in Britain

Britain's Chancellor of the Exchequer George Osborne leaves Downing Street in London, December 4, 2012. Osborne will invest 5 billion pounds
Britain's Chancellor of the Exchequer George Osborne leaves Downing Street in London, December 4, 2012. Osborne will invest 5 billion pounds

By Matt Falloon and David Milliken

LONDON (Reuters) - More austerity looks certain when British finance minister George Osborne presents a half-yearly budget statement on Wednesday, even if he tries to juggle some spending around to ease the pain.

A darker economic outlook means Osborne is likely to commit to further spending cuts years into the future to save his flagship deficit reduction plan, though he also plans some new investment to sweeten the pill in the short term.

Osborne, who will update parliament with new growth and budget deficit figures just after 7:30 a.m. EDT (1230 GMT), may have to admit borrowing will rise this year -- an embarrassment for a man who put frugality at the heart of the government's policy.

His austerity targets are under threat and a sluggish economy has played havoc with the Conservative-Liberal Democrat coalition's original plan to eliminate a large structural budget deficit before the next parliamentary election due in 2015.

Prime Minister David Cameron sent out an early message on Twitter after Osborne briefed the cabinet on the forecasts, saying: "We are on the right track and making progress."

However, depending on how bad the independent Office for Budget Responsibility's growth and borrowing estimates turn out to be, Britain could be in danger of losing its prized triple-A credit rating before long.

Growth in Britain's service sector slowed to a snail's pace, a closely-watched Markit/CIPS survey showed, suggesting the economy could be on the verge of contraction again.

The chances of Osborne masterminding a strong recovery in time for voters to feel the benefits before a 2015 election appear to be shrinking. Only one in five voters trust him to fix the economy, according to a Comres/ITV News poll.

"The picture of stagnation is a problem," said Rob Wood, an economist at Berenberg Bank, arguing that Osborne will probably have to announce more austerity for the years after the 2015 election. "Deficit reduction has gone into reverse this year."

The economy grew one percent in the third quarter, bouncing back from three quarters of decline, but few expect a roaring recovery next year without some solution to the protracted debt crisis in the euro zone, Britain's main trading partner.

In the absence of the strong growth predicted when Osborne took the reins of the Treasury in 2010, he has been forced to extend spending cuts well beyond the next election. He may have to stretch out those cuts even further into the future.

Back in March, the OBR forecast growth of 0.8 percent this year, 2 percent in 2013 and nearly 3 percent thereafter. Economists polled by Reuters now expect output to fall 0.1 percent this year, followed by 1.1 percent growth in 2013 and 1.7 percent in 2014.

CUTTING TOO FAST?

Critics accuse Osborne of strangling growth by cutting government spending too fast and, in turn, scuppering any hopes of reaping the tax revenues needed to deal with Britain's budget deficit -- which hit a record above 11 percent of GDP shortly before the 2010 election.

"Wednesday's Autumn Statement on the economy is a chance for ... Osborne to recognize things haven't worked out as he promised and try a different approach," Ed Balls, economy spokesman for the opposition Labour Party, said on Monday.

"He should take the opportunity to do so, because the country will not forgive him if he puts political pride first and ploughs on recklessly with a failing plan."

Osborne's supporters say that changing course now would unsettle financial markets, drive up the cost of borrowing and put Britain's economy in even greater jeopardy.

Instead, the Conservative will juggle the numbers to find money for investing in infrastructure, while holding fast to his austerity plan -- even if that means more spending cuts to make up for lost tax income.

"To turn back now ... would be a complete disaster for our country," Osborne told the BBC on Sunday.

He will detail 5 billion pounds ($8 billion) of spending on schools and transport on Wednesday, largely paid for by cuts across government departments over the next 2-1/2 years, and flesh out plans for a new clampdown on tax avoidance.

A strategic plan for Britain's gas production industry is also expected, following an October announcement of tax breaks for the fledgling shale gas sector.

Osborne will argue that the burden of any extra austerity must be spread across society, with further cuts to the welfare budget and some form of taxation on the wealthy, possibly a property tax and a limit on pension tax relief.

It is unclear how a 35 billion pound windfall from the Bank of England's 375 billion pound asset purchase scheme will be accounted for in the public finances, but it is a timely gift for Osborne and will reduce Britain's debts.

The OBR may well extend the time needed before Britain's structural current budget returns to balance by a year to 2017/18.

And Osborne may be forced to abandon one of his key fiscal policy rules -- to see debt falling as a percentage of Britain's national output by 2015/16. He could replace that rule with something less specific to keep markets on side.

(Editing by Mike Peacock)

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