Andrew Lilico: Autumn Statement - Osborne takes his cue from Marshall Foch

"My right is hard pressed. My centre is yielding. Impossible to manoeuvre. Situation excellent. I attack."

This is the famous laconic aphorism attributed to Marshall Foch at the Battle of the Marne in 1914.  It could also be seen as the inspiration for George Osborne's political strategy in his 2012 Autumn Statement.

On his right Osborne is hard pressed by those that say for all the government's tough rhetoric about cutting spending to cut the deficit, two years in to the Coalition's Plan A government consumption spending - spending on public sector salaries and the like - hasn't fallen.  Though the deficit has fallen a little, it has not fallen anything like as fast as the government hoped or planned.  The 2010 Conservative Manifesto and the incoming Coalition government promised to eliminate the structural current deficit over a Parliament, with Alistair Darling's deficit reduction plan being dismissed as incredible precisely because it anticipated taking much longer than one Parliament to eliminate the deficit.  In early 2010 George Osborne set a number of "benchmarks" for his period as Chancellor and for a Conservative government, of which the first and most important was that the UK would maintain its AAA rating.  He made a virtue of being held to account against these benchmarks.  But with both the original deficit reduction target and now (in the Autumn Statement) the debt reduction target being abandoned, with the UK's deficit falling only £1bn this year (from £121bn in 2011/12 to £120bn in 2012/13), and with growth forecasts being downgraded yet again, the AAA is now likely to go.

To try to keep the AAA, Osborne would have had to attempt additional significant spending cuts. He says £17bn would have done it.  I think £25bn is more like the required figure.  The only budgets he could conceivably have obtained additional savings on this scale were health and schools - the budgets ringfenced in 2010.  He was never, politically, going to do that short of some crisis of epic proportions (such as the collapse of the euro or a gilts strike).

Like Foch, Osborne's support from the centre is giving way.  With their hopes of proportional representation in the Commons dashed in the AV referendum and in the Lords dashed by the heroic efforts of Jesse Norman et al, splitting from the Conservatives over state regulation of the press and renegotiation with or exit from the EU, and with their opinion poll ratings consistently at or below those of UKIP, the appetite of the Lib Dems to bear yet more political pain for deficit reduction is entirely absent.  They, instead, agitate for mansion taxes and reject outright any suggestions of material additional spending cuts.

The government dreams of releasing a boom in infrastructure spending, but has no scope to cut interest rates to stimulate a private sector boom or borrow more to fund a significant expansion to public sector capital spending.  If inflation were low enough it might contemplate instructing the regulators of water, gas, electricity, rail, airports, and so on to allow more rapid price rises to fund additional infrastructure programmes in these areas.  But inflation is uncomfortably high and rises to utility bills are blamed upon the government - and would be doubly so if the government explicitly instructed such.  Like Foch, Osborne's room for manoeuvre is almost entirely absent.

So what did he do in the Autumn Statement?  Like Foch, he attacked.

He said straightforwardly that he was going to miss his debt reduction target - a refreshing change from last year when he abandoned his target of eliminating the deficit over the Parliament but pretended he hadn't.  He made a virtue of this.  To those on his right he said that he was going to miss his target because of international events beyond his control - since these were beyond his control, why did it make sense for him to cut spending in response?  And if he were to cut spending, he said £17bn would be required - what did those to his right want to cut that would raise £17bn?  They might complain about him, but the reality was that he was actually doing something about cutting the deficit, and no-one that might potentially replace him would actually do so.

To his left, he noted that part of his fiscal problem is that the recession the Labour Party had overseen was even worse than previously thought - revised up to a 6.3% contraction from a 5.8% one.  International events might have retarded his progress, but Labour's plans were even more dependent on now woefully over-optimistic forecasts for growth in international trade and normalisation of international financial conditions than were his own.  His progress might have been retarded - but under their plans things would have gone backwards apace.

In the centre, the two key economic matters this government hopes to be remembered for are cutting the deficit and raising the personal income tax allowance.  Osborne pressed forward here like a Norse beserker fearless of danger.  Who says there's no money left?  He raised the personal allowance further.

At the height of the recession, at the Conservative Party Conference of 2008, the "fair fuel stabiliser" was one of the Party's main proposals for easing the pressure on household budgets. With energy costs high again, and the potential for oil prices to rise further as matters deteriorate in Syria and Iran, fuel duty was back under the spotlight.  Osborne pressed on the attack here, too, despite the collapse of his debt and deficit reduction strategies.  The 3p fuel duty rise next January would not simply be deferred - it would be abandoned.  Cue much cheering from the government benches.

This is all very well, exhibiting the political and tactical panache we've come to expect from Osborne.  But it is a huge political gamble - one that I think likely to go bad for him.  (I say that with sorrow, since I am one his biggest fans and, in economic and fiscal terms, most robust supporters.)  First, the UK's AAA rating is likely to go in the New Year - probably when the 2012 Q4 growth numbers come out in late January 2013.  He said we should judge him by whether the AAA was maintained.  When it's not, he will be judged.  Most commentators suggest the consequences will be mainly political, with limited economic effects.  I'm not so sure about that.  Even relatively modest rises in UK gilt yields would impose losses on UK banks forced to load up on UK gilts by regulation.  Those banks are already said to be £60bn under-capitalised.  If they started to seem likely to make future losses on gilts - with perhaps more credit rating downgrades to come later - there would be very little appetite to recapitalise UK banks from private sector equity injections.  But if the private sector wouldn't recapitalise them, where's the money to come from?  The UK government?  When it is already missing its debt targets, is it to devote even more money to bailing out bust banks?  The OBR report confirmed that losses on the 2008/9 bailouts are still rising - where now Vince Cable's claim that there would be a profit from bailing out the banks?

Osborne got much of the money for the fuel duty cut and personal allowance rise by decoupling the rises in tax allowances and benefits from inflation from 2014 on.  The consequence is that if inflation is higher than expected, taxes will rise more and benefits will be cut more than expected.  Inflation late in the Parliament has long been the likely doom for Osborne.  He won't be able to blame the Eurozone crisis or Gordon Brown for that.  Inflation will be purely a made-in-Osborne problem.  Rises in the cost of living are amongst the most politically toxic government failures at the best of times.  But Osborne has now doubled up on this, because with the tax allowance and benefit upratings decoupled from inflation, high inflation will add political unhappiness with automatic extra tax rises and benefit cuts into the mix.

Osborne has responded to the disintegration of his fiscal strategy with a bold political attack.  He remains the best show in town - our best hoped for achieving anything in terms of getting the deficit down.  But with the growth outlook getting worse and worse, with austerity scheduled to last longer and longer, and with the political damage of now-near-inevitable high inflation getting worse and worse, I fear that being the best show in town will not ensure him an eager audience for too much longer.