The strength of the rebound in the tax take – which often surprises on the upside in the early stages of a recovery – should also see full year HMRC receipts for 2010/11 come in around £4bn ahead of forecast, largely due to robust growth in income tax which accounts for £3bn of the total overshoot.

Chancellor should resist temptation to provide sweetener to bitter fiscal pill

However, ITEM is cautioning the Chancellor against introducing any early spring give-aways in the Budget, as it believes it's still too early to judge whether or not the improved fiscal position can be sustained over the rest of the parliament.

Andrew Goodwin, senior economic advisor to the Ernst & Young ITEM Club says, "So far the fiscal plan is on track, which is good news for the Chancellor. But the Treasury needs to resist the temptation to utilise the windfall to provide a little sweetener to the bitter pill of fiscal retrenchment – it is still very early days on the long and challenging road to fiscal balance."

In recent months the risks to economic growth have shifted to the downside, following a surge in global commodity prices which are feeding into rising inflation. ITEM believes this could lead to more aggressive tightening of monetary policy both at home and abroad, as well as potentially dampening growth, principally through the impact on consumers' spending power. "The higher that oil prices rise – and the longer they remain high – the greater the threat to UK growth prospects. The pressures on commodity prices have been building for some time, mainly due to concerns about the impact of strong emerging markets growth, but the risks have intensified in recent weeks with the unrest in the Middle East and North Africa," Goodwin remarks.

Weaker medium term growth – but Chancellor should meet fiscal mandate

The increase in downside risks coupled with ITEMs forecast that revenue growth will be a little weaker and PSNBX slightly lower than the OBR is projecting over the medium term, all point towards a very small margin for error in achieving the government's fiscal mandate, according to Goodwin.

"Given how wary the Chancellor has been of sending the wrong signals to financial markets, we expect him to hold back the bulk of his windfall to guard against potential slippage later on. Our current forecast still shows the Chancellor achieving his fiscal mandate of restoring the cyclically-adjusted budget to balance by 2015/16, albeit by a narrower margin of around 0.5% of GDP."

This all points to a Budget that is likely to be relatively light on major policy announcements, with the Chancellor confined to tinkering around the edges of policies that are largely revenue-neutral and designed to promote growth.

Budget predictions – freezing fuel duty

Looking ahead to what measures the Chancellor may be storing in his briefcase this year, ITEM predicts that the increase in fuel duty implied by the fuel duty escalator could be scrapped, at least for this year.

Goodwin says that households and businesses are already under significant pressure from the effects of rising fuel costs and adding to this by raising fuel duty would damage UK growth prospects. "While scrapping the rise in fuel duty would reduce the planned £1.6bn in additional tax take from this source, this would be partly offset by the fact that higher oil prices will mean stronger corporation tax receipts from North Sea oil companies."

Enhancing UK competitiveness

There have also been calls for the Chancellor to lay out a detailed strategy to promote economic growth. While a number of business-friendly policies have already been implemented, such as the staged reduction in corporation tax, ITEM believes that more needs to be done to improve UK tax competitiveness. With this in mind ITEM would like to see a commitment from the Chancellor to remove the 50p tax rate once public finances have improved, to help provide a better climate for growth.

Keep calm and carry on

Goodwin concludes, "Better news on the government finances will provide a welcome relief for the Chancellor as he announces his first official Budget. But we are at the start of a very long and treacherous road and there will be many more obstacles to negotiate before the government's finances are restored to balance. That said we think the Chancellor, based on our current forecast, should meet his fiscal mandate. But for now there are unlikely to be any spring give-aways in this week's Budget."