This week Alistair Darling is asking banks to support business customers in these difficult times and not just when times are good. The Chancellor has said that it is vital to support small businesses through the downturn and announcing an extra £4 billion of support.

As a part of the multi-billion pound bailout deal put forward to the UK’s leading banks by the government was a condition that they restore the level of funds available to small businesses to those of 2007 levels.

World interest rates

This week also saw the Chancellor Alistair Darling re-stating his support for the Bank of England, despite criticism that it had been focusing too much on inflation. The Chancellor confirmed that there is no reason to change the Bank’s main goal of keeping inflation to close to the 2% target. The change in words or in the way the message has been sent to the Bank of England is about the discretion over the horizon over which inflation is brought back to this target level.

We watch and wait to see what the Bank of England does next week with interest rates where we see countries around the world have again been cutting their rates. We saw the US Federal Reserve cut interest rates from 1.5% to 1% on Wednesday of this week and Japan cut their rates from 0.5% to 0.3%.

It is of no surprise that the US is cutting interest rates when it was confirmed by figures from the Commerce Department that the US economy shrank at an annualised rate of 0.3% between July and September. Consumer spending, which makes up two-thirds of the US economy, also shrank by 3.1%, which is the first contraction since 1991.

The chance of a interest rate cut in Europe is more likely where inflation for October across the 15 nations that share the euro fell to an annual rate of just 3.2%. The rates presently sit at 3.75% and are expected to be cut by a half-point to 3.25%.

The motor industry

It is good to recognise the good news out there with Volkswagen going against the economic slowdown and reported increased profits. VW’s net profit rose 28% to €1.2 billion ($1.6 billion; £950 million) in the period July to September. Their sales have been boosted by three out of the four BRIC emerging market economies, China, Russia and India, which has off-set lower demand in Europe and the US.

As a contrast to this Japanese carmaker Suzuki issued a profit warning this week and the company blamed the fall in sales down to India, which is one of their key market. The strong yen and higher material costs have not helped their figures where they have said that their net profits will probably fall 25% to 60 billion yen ($612 million; £379 million) in the year to the end of March.

Trouble for pension fund trustees

There is a double whammy for pension funds right now with falling stock markets reducing fund values. But pension scheme trustees are being warned that they should not be too quick to start demanding extra cash from companies at this time which might put too much pressure on those companies at a very difficult time. A longer term view is needed and when the economy is straining with a huge turn-down if pension trustees were to start asking for extra funds might be enough to tip some companies over the edge.

News on the banks front – Barclays bank has secured £7.3 billion of extra investment cash from the Middle East this week. The money is being raised on the whole from state investment funds and royal families of Qatar and Abu Dhabi and unlike some of the other top banks of the UK, Barclays will not be accepting a cash injection from the government. A bank that has been troubled by the world banking crisis HBOS has been approached by a mystery bidder at a time when the UK government has given the green-light for the takeover of the company by Lloyds TSB.

Alitalia appears to be near to a rescue deal being agreed, but as with all the rescue deals posed so far the unions have been putting obstacles in the way. In this latest deal five out of the nine unions are still not backing this new deal, which does seem bizarre because unless the company can secure additional finance, should this deal not go through, the company will go bankrupt. Investment group Cai has said that the deal will still go ahead, despite the lack of agreement with the trade unions.

More on oil price volatile

Oil prices finished the week slightly higher on the week ending at $67.59, as we see results from the oil giants at record levels. For example, US oil group Chevron has seen its latest profits more than double when it reported its third-quarter results to September showing a net profit of $7.89 billion (£4.9 billion), which is up from $3.72 billion for the same period last year.

Exxon Mobil has also made record profits after reporting that it made a profit of $14.83 billion (£8.97 billion) between July and September, representing a rise of 58% on the same period last year. Oil firm Royal Dutch Shell has also reported excellent profits as a result of record oil prices with a jump of 71% in its third-quarter profits to $10.9 billion (£6.6 billion). BP reported earlier that its profits during this same period more than doubled to $10bn.

British Prime Minister Gordon Brown has called for oil price stability and has made a special trip to the Middle East in order to ask the Gulf states to help stabilise prices with the aim to help tackle the global economic crisis. The UK prime minister held talks with Saudi ruler King Abdhullah at the King’s Palace in Riyadh being joined by his Energy Secretary Ed Miliband.

On the jobs front we see more redundancies

American Express has revealed plans to reduce its workforce by around 7,000, representing a cut of about 10%. This together with a freeze on some salaries to reduce costs and a suspension to pay rises for management next year are part of a $1.8 billion (£1.1 billion) cost cutting exercise.

On the housing sector

There has been a slight change on the number of mortgages approvals for house purchases in the UK in September. According to the Bank of England 33,000 home loans were approved in September representing a small rise of 1,000 compared with the record low of the previous month. It is thought that this rise in mortgage approvals is partly due to the government raising the stamp duty threshold to £175,000 in early September.

However, despite the above improvement there is trouble on the repossession front with the number of people losing their homes climbing sharply. The number of repossessions in the second quarter of the year was 11,054, which is up by 71% over the same period last year.

End of the week saw:
Stock exchanges:
FTSE 100: 4,377
DOW: 9,325
S&P: 967
Nikkei: 8,577

Currencies
UK Sterling £ to US Dollar $ 1.61620
UK Sterling £ to Euro € 1.2727
UK Sterling £ to Aus $ 2.44394
US Dollar $ to Euro € 0.787465

Commodities
Crude oil – $67.59
Gold – $725

The chancellor has insisted it is his duty to be straight with the public, after telling a newspaper the UK faces its worst economic crisis in 60 years.

Alistair Darling told the Guardian the downturn would be more “profound and long-lasting” than most had feared.

Shadow chancellor George Osborne said Mr Darling had “let the cat out of the bag” about the state of the economy.

But Mr Darling told the BBC it was important to explain the “unique” problems being faced globally.

“This coming 12 months will be the most difficult 12 months the Labour party has had in a generation, quite frankly” Alistair Darling

The chancellor admitted, in his newspaper interview, that the government had “patently” failed to get its message across that it understood people’s concerns about rising living costs and growing job insecurity.

He said that voters were “pissed off” with Labour’s handling of the economy, a key issue at the next election, and said it was “absolutely imperative” that ministers communicated their intentions better.

When asked why he had been so frank, the chancellor told BBC News: “I think it is important that government ministers and particularly me as Chancellor level with people.

“I explained that what is happening to every country in the world, ours included, is that we have a credit crunch the like of which we have not seen for generations.

“We have that at the same time as oil and food prices going up. But I also am clear that the fundamentals of our economy are strong.”

He said the current government differed from previous ones because it is prepared to “take action to help the economy and to help people get through this difficult time”.

He cited the rescue package provided for Northern Rock and tax rebates due at the end of next month as examples of assistance offered by the government.

Shadow chancellor George Osborne reacts to Alistair Darling’s “remarkable” interview
Ministers are expected to announce a package of measures next week to kick-start the moribund housing market.

The chancellor has been criticised for sending contradictory signals over possible measures to assist homebuyers, particularly the prospect of a temporary suspension of stamp duty on home purchases.

In a wide-ranging Guardian interview, Mr Darling said Labour had to rediscover its “zeal” if it wanted to be re-elected for a fourth term.

Mr Darling hinted at tensions within Gordon Brown’s Cabinet, saying there were “lots of people who’d like to do my job” and “no doubt, actively doing it”, although he appeared to rule out an autumn Cabinet reshuffle.

The chancellor’s remarks come after a summer of bad economic news.

House prices are falling at their fastest rate in 18 years, leading to fears of a wave of repossessions.

Mortgage lending has slowed dramatically due to the credit crunch while key indicators have suggested that the economy could be poised to go into recession.

Vince Cable reacts to the Chancellor’s assessment of the UK economy

The economy showed no growth in the second quarter of the year while building firms and retailers have laid off thousands of staff amid fears that the economy will deteriorate further.

A member of the Bank of England’s Monetary Policy Committee said on Friday that radical action was needed to ensure the crisis did not get worse and warned of a sharp rise in unemployment.

Mr Osborne said: “Who is telling the truth at the top of government?

“The prime minister says the economic situation isn’t as bad people think and that Britain is well placed to weather the economic storm but the chancellor says we are at a 60-year low.

“Gordon Brown has briefed out stories that he has an economic recovery plan all worked out, meanwhile the chancellor says the downturn will be more profound and long-lasting than people thought.

“It’s not clear whether Alistair Darling meant to tell us the truth about the mess 10 years of a Labour government has left our economy in, but he has certainly let the cat out of the bag.”

“He has come out and been frank, but I have no sympathy and nor I hope has anyone else!” James, Surbiton

Send us your commentsLiberal Democrat Treasury spokesman Vince Cable said the government had been inconsistent with its message.

“Until very recently there was no problem, there was a state of denial, Britain was the strongest country in the western world, any problems we had were from overseas,” he said.

“Now suddenly we’ve lurched into Apocalypse Now, the return of the Great Depression.”

The Treasury said the chancellor’s comments were “entirely consistent” with his previous statements.

A spokesman said: “These are the same difficult economic circumstances that every other country in the world is having to deal with.

“But with employment levels near record highs, interest rates that are historically low and the past decade of rising incomes and job creation, the UK is well placed to deal with this.”

News reported by The BBC

David Cameron has attacked the government for a “completely reckless” briefing that stamp duty could be axed temporarily to boost house sales.

“Far from freeing up the housing market, they have actually frozen it,” the Conservative leader told reporters.

He is holding talks later with the National Association of Estate Agents (NAEA) – a body he claims the government has refused to meet.

It comes after Alistair Darling refused to rule out changes to stamp duty.

Estate agents have already warned that uncertainty over the government’s policy on the tax could cause people to delay buying houses.

Leak inquiry?

Speculation was fuelled by a report in last Tuesday’s Sun newspaper that the government planned to offer a holiday from stamp duty payments to revive the flagging sector.

When tackled about the story on Wednesday’s Today programme, the chancellor said a “number of measures” were being considered – but the government had come to no conclusions.

The Treasury later issued a statement saying: “Recent news stories suggesting the government has put forward a proposal on stamp duty are simply wrong. These stories are based on speculation.”

“Their decision to brief out the possibility of a stamp duty holiday was completely reckless” David Cameron Conservative leader

According to some reports, the original briefing came from Downing Street and was aimed at undermining Mr Darling – something firmly denied by Number 10.

Mr Cameron, who has returned to the political frontline, following a holiday in Cornwall, said the debacle showed the government was more interested in “press handling and headlines than what is in the best interests of the country”.

He urged the government to adopt the Conservatives’ plan to abolish stamp duty for nine out of 10 first time buyers.

“When it comes to the crisis in our housing market they seem intent on making things worse rather than better,” he said.

North East tour

“Their decision to brief out the possibility of a stamp duty holiday was completely reckless – far from freeing-up the housing market they’ve actually frozen it.

“Have they even got a leak inquiry to find out how this was briefed out? I think not. I think they know exactly where it came from.”

Mr Cameron, who will tour marginal constituencies in the North West of England before resuming his summer break with a holiday in Turkey next week, is set to meet with housing trusts, city economists, academics and house builders to discuss the property market.

The group will look at the mortgage market, repossessions and the housing supply, he said.

“We won’t be announcing any conclusions today. We won’t be briefing out thoughts today. This is a seminar to look at the issues – it’s to engage with the experts to help us develop our policies.”

‘Unacceptable’ behaviour

He refused to repeat a claim by shadow foreign secretary William Hague that the Conservatives were the “likely winners” of the next general election, stressing that there was no “complacency” in his team.

“I never use those words because the election is up to the members of the public to vote and you can’t make any presumptions about the way they are going to,” he said.

He also condemned the “completely unacceptable” behaviour of Ian Oakley, a Tory general election candidate for Watford, who admitted a campaign of harassment against his Lib Dem rivals.

The Liberal Democrats have urged him to investigate the “vile campaign” by Oakley, who quit the party following his arrest.

Oakley, 31, of Ryeland Close, West Drayton, north west London, appeared at St Albans Magistrates Court last week to admit five counts of criminal damage and two of harassment against Liberal Democrats.

He asked for 68 other offences to be taken into account. He is due to be sentenced in September.

Miliband praise

The monthly briefing comes as ex-local government minister Nick Raynsford accused Labour of being in a “deep hole” and warned that attempts to “buy” support would only invite contempt.

Writing on newstatesman.com, Mr Raynsford accused the government of a “frantic search” for vote-winning ideas.

He failed to mention Gordon Brown, but praised the call by Foreign Secretary David Miliband to “start winning the argument over our record”.

Mr Miliband fuelled speculation over the Labour leadership when he penned an article two weeks ago calling on colleagues to have the confidence to make their case afresh – but without making a reference to the prime minister once.

The prime minister, who is on holiday, is expected to launch a fightback in September.

News reported by The BBC

I have learned that the Treasury may give a taxpayer guarantee to billions of pounds of bonds known as mortgage-backed securities created by banks out of high quality mortgages, in a radical attempt to revive Britain’s rapidly shrinking mortgage market.

Officials from the Treasury are examining such an ambitious and controversial scheme in response to a dire assessment of the outlook for mortgage finance to be published at 10am today by Sir James Crosby, the deputy chairman of the City watchdog, the Financial Services Authority.

Sir James is forecasting that a chronic shortage of mortgage finance for homebuyers and homeowners which has persisted for months will continue throughout this year, 2009 and 2010.

In April, Sir James was asked by the chancellor, Alistair Darling, to examine what “market-led initiatives” might be necessary to improve the functioning of markets in mortgage-backed securities.

He was commissioned to do this because of the importance of the market for mortgage-backed securities, which grew explosively after 2000 and became a vital source of funding for British mortgage lenders.

Sir James is understood to have concluded that by 2006 finance from the sale of these securities – which are packages of mortgages lent to homebuyers – was equal to two-thirds of all net new mortgage lending in the UK.

By the end of last year, the total stock of UK mortgage-backed securities was a staggering £257bn – equivalent to around a fifth of the value of the British economy – out of total residential mortgages of £1200bn.

But almost exactly a year ago, with the onset of the phenomenon now known as the credit crunch, demand for these bonds completely dried up.

It has since become almost impossible for any bank to issue mortgage-backed securities. So banks simply don’t have the cash to meet even the current reduced demand for mortgages from homeowners who need to refinance their debts and from prospective homebuyers.

As I wrote in May leading banks are expecting the net increase in mortgage lending to fall to £60bn in 2008, from £110bn last year and a similar amount in 2006. That’s a drop of 45% – a shrinkage that reflects a collapse in mortgage approvals for house purchase.

Nor is the plunge of the mortgage-backed securities market the only funding difficulty being experienced by banks. They are struggling both to raise other forms of wholesale funding and to extend the maturity of their existing debts

Also the squeeze on the money they have available for new mortgages is exacerbated – according to Sir James – by their obligation to repay around half of their existing mortgage-backed borrowings over the coming three years.

And adding to the banks’ woes is that as they reduce the supply of mortgages and increase the cost of homeloans, there is likely to be a rise in the number of mortgage holders who can’t pay their debts. A consequential increase in defaults would further deplete their capital resources and their ability to lend.

So, broadly, mortgage finance is now only available to those with utterly reliable earnings and deposits equivalent to at least 25% of the value of what they want to borrow.

Sir James warns that the availability of finance to all other consumers – including most first-time buyers – is much reduced and likely to remain so.

As for what little lending there is, that’s now dominated by the UK’s biggest five or six banks, with small banks and building societies making almost no new loans. Sir James expects many mortgage intermediaries to disappear.

He also expects the shortage of mortgage finance to exacerbate the fall in house prices (doh!) and the weakness of consumer spending (double doh!).

What’s to be done?

He believes it may make sense for the government to attempt to re-open the market for mortgage-backed securities, to prevent the banks becoming so strapped for cash that the housing market would go from decline to meltdown.

Sir James says there are two leading contenders for government intervention in this market.

One would be something along the lines of an idea put forward by the Council of Mortgage Lenders, with the Bank of England becoming – in effect – the market-maker of last resort for mortgage-backed bonds.

On this model, which would be seen as an extension of the £100bn so-called Special Liquidity Scheme the Bank announced in the spring, the Bank would agree to lend to almost any financial or investment institution against the security of mortgage-backed bonds bought by the relevant institution.

The Bank would be guaranteeing that if the market for such bonds were shut, it would make sure that the bonds did not become totally illiquid.

However the much more radical suggestion mooted by Sir James – and under active review by the Treasury – would be for the government to guarantee, on commercial terms, billions of pounds of better quality tranches of new mortgage-backed securities.

Or to put it another way, the taxpayer would be providing a promise that it would pick up the tab in the event that the value of of those securities was impaired by a huge rise in repayment difficulties or defaults by mortgage borrowers.

Which would be pretty controversial, as it would be seen as taxpayers underwriting a huge slug of the mortgage market.

Some would argue that our entire mortgage industry would be nationalised, although that would probably be overstating it.

To be clear, Sir James may yet – when he issues his final report in September or October – recommend that the government should not intervene, on the basis that such intervention may create more difficulties than it would solve.

But the tenor of his report suggests that there would be significant risks to the health of the economy from doing nothing.

And although the chancellor, Alistair Darling, has no intention of trying to prevent house prices from falling – in that he acknowledges that it would be mad and futile to attempt to rig the housing market in a fundamental way – Darling is deeply troubled by the risk that the chronic shortage of mortgage finance could lead house prices to fall much further and faster than would be warranted on the basis of notional economic fundamentals.

What Darling would like to prevent, if he possibly can, would be house prices overshooting on the way down, just as they overshot on the way up, and thereby wreaking massive damage to the economy.

With the full force of the tide against him, he’ll find that a challenge.

News reported by The BBC

Alistair Darling will this week bow to pressure from business by scrapping contentious reforms to the taxation of foreign profits that threatened to provoke an exodus of companies from the UK.

The concessions mark the latest in a string of climbdowns by the chancellor, who has been forced to rewrite large sections of his Budget and pre-Budget report, including proposals on income tax, capital gains tax and fuel duty.

EDITOR’S CHOICE
Tax exemption nettle stings chancellor – Jul-20Alert over Revenue’s £2.7bn shake-up – Jul-18Audit spots possible £1.5bn tax credit error – Jul-15Small businesses on verge of tax rebellion – Jul-11Calls for big shift to green taxes under fire – Jul-10Business pushes for tax concession – Jul-10The latest retreat follows a furore over proposals set out by the Treasury last year to crack down on tax avoidance, as a quid pro quo for exempting foreign profits from UK tax.

Proposals in the discussion document to impose a worldwide tax on “passive” income, such as royalties from intellectual property, provoked a backlash from leading UK multinationals.

Shire, the UK’s third-biggest pharmaceuticals company, and United Business Media, the publisher, this year decided to relocate their headquarters to Ireland for tax purposes.

The head of Shire told the Financial Times that his company had made significant savings from its spring relocation. Angus Russell, the chief executive and former finance director who masterminded its move to Dublin, said he had been approached by other companies for advice on relocating.

The Treasury will this week announce that these anti-avoidance proposals have been axed. Ministers are expected to recommit to the principle of exempting foreign profits from tax, subject to protecting the UK’s tax base from erosion.

However, the means of achieving that protection – the catalyst for the outcry – will be the subject of talks with business, rather than a Treasury diktat. Any proposals will not be agreed before the autumn, at the earliest.

The Treasury decision will be set out in a reply to a letter from the CBI employers’ organisation, being sent on Monday or Tuesday.

The Tories are likely to attack the move as a sign of government incompetence, but one official said the decision showed that the consultative process was ­working.

“Some people will see this as a climbdown, but it’s a sensible, positive reaction to the feedback we’ve got, which we think will be welcomed by business,” he added.

Ministers accept the multinationals’ argument that the proposed regime would have had a disproportionate effect on certain sectors, hitting companies with relatively high levels of global intangible assets.

“Business felt the changes [to the anti-avoidance] rules were not acceptable or workable and we’re talking with them to resolve those concerns,” a Whitehall official said.

“The proposals in the discussion document are all being rethought – we’re not taking them forward.”

News reported by The FT

The stock market tumbled to its lowest level since 2005 yesterday as grim news on inflation and the worsening financial crisis in the United States hit shares.

Inflation jumped to 3.8 per cent in June, nearly double the Bank of England’s 2 per cent target. The bigger-than-expected rise intensified fears that the Bank would not be able to cut interest rates to stop the economy slipping into recession. Inflation is now running at the fastest pace since the Bank gained independence over interest rates in 1997.

Andrew Sentance, a member of the Bank’s Monetary Policy Committee, warned that living standards would be squeezed and unemployment would rise as the Bank battled to keep inflation under control. He said the Bank was worried that expectations of higher prices would cause inflation to become entrenched as it did in the 1970s.

The Bank of England will be watching today’s labour market data carefully for any signs that average earnings are on the rise.

The Chancellor, Alistair Darling, urged people not to push for higher wages, saying it would only lead to a wage-price spiral. “Whether you are in the private sector or the public sector, whether you are sitting in the boardroom or working on the shop floor, we cannot allow inflationary wage increases,” he said.

Sterling hit $2.0153, its highest against the US dollar for three-and-a-half months, and the pound also rose against the euro.

There was more bad news for the key housing and retail sectors. The Royal Institution of Chartered Surveyors’ survey for June pointed to further house price falls in the months ahead, with sentiment in the property market near record lows. The British Retail Consortium said May’s jump in sales did not last and that retail sales fell last month despite deep discounts to get shoppers through the door.

The FTSE 100 dropped 2.4 per cent as bank stocks hit a 10-year low. Royal Bank of Scotland was the biggest faller, dropping 7 per cent to a new low for the year as fears increased over the housing market in the US, where RBS is the biggest foreign bank.

Ben Bernanke, the chairman of the US Federal Reserve, told Congress that his concerns about economic growth and the threat of inflation had intensified. Shares of Freddie Mac and Fannie Mae, the companies that guarantee or own nearly half of the US’s $12trn mortgages, slumped again as doubts about their future persisted despite the federal government’s rescue plan announced on Monday.

The Dow Jones Industrial Average fell by more than 2 per cent but recovered to trade up slightly by lunchtime in New York after the price of oil tumbled 5 per cent. The fall eased concerns about rocketing energy prices but was caused by an expected drop in demand from the US economy.

News reported by The Independent

In keeping with the calls for wage restraint to help curb commodity price-induced inflation, the Governor of the Bank of England is forgoing a pay increase that could have seen his salary rise by more than £100,000 a year.

A review by independent consultants in 2006 concluded that Mervyn King’s remuneration package was not commensurate with the size and responsibilities of his role, and it recommended an increase of as much as 40 per cent at the top end of the scale. Under the terms of the proposed package, the Governor’s salary was to rise from £288,290 to a range from £375,000 to £400,000, from the start of his second five-year term this month.

But the offer was refused in favour of a sub-inflationary 2.5 per cent raise, according to the Bank’s annual report, published yesterday. “Mr King declined to accept the new package and retained the salary and annual increases which applied during his first term,” it says.

The Governor’s abstinence is particularly noteworthy following the Chancellor’s calls, in last month’s Mansion House speech, for moderation in wage negotiations to avoid fuelling rising inflation. So far this year, after more than a decade of stability, the Governor has been called upon to write to Alistair Darling twice to explain why inflation is higher than the target of 2 per cent. Most recently, in May, the inflation rate was at 3.3 per cent, and the Bank’s own predictions are that it will hit 4 per cent in the medium term before getting back down to acceptable levels.

Mr King used the publication of the annual report to re-emphasise the rationale behind the Bank’s Monetary Policy Committee (MPC) decision to continue to hold interest rates steady, rather than use a raised rate as a mechanism to control inflation.

“The MPC can have little impact on the path of inflation in the short term,” the Governor said. “It has not attempted to prevent inflation moving away from the target following the sharp rises in commodity prices. To do so would have required a large increase in interest rates with such a severe impact on output and employment that it would have risked inflation falling well below target further out.”

But the Bank is on a watching brief. “The dilemma that has made our task so difficult since last summer is that we have had to balance this risk that inflation expectations might be dislodged against the possibility that inflation might fall below the target,” Mr King said. “These are judgements the committee must continue to make month by month.”

The Bank of England report also confirms that the non-contributory Court Pension scheme previously offered to Bank executives has been closed to new members. While existing members of the scheme will continued to accrue benefits according to the original terms of their agreements, newly appointed executives will have the option of either the Career Average scheme available to all staff or a salary supplement of between 15 per cent and 30 per cent.

News reported by The Independent

Alistair Darling must do more to help the 1.1m low-income households still losing out as a result of the scrapping of the 10p tax rate, MPs have said.

A £2.7bn emergency package announced by the chancellor last month did not go far enough, the cross-party Commons Treasury committee said in a report.

The money had not been “well-targeted”, with £2bn going to middle-income workers who had not lost out, it added.

Mr Darling has said he wants to do more to help those not already compensated.

The committee’s report said the chancellor’s decision to raise the income tax threshold by £600 in May, at a cost of £2.7bn, was “probably the least bad option” to mitigate the impact of the abolition of the 10p rate.

“The government’s short-term priority must be to make every effort to compensate these people in full” John McFall Committee chairman

It found the 5.3m losers from the initial decision were people on low incomes for whom the loss of up to £232 a year had dealt a “significant” blow to their finances.

This, it noted, came at a time of sharply rising prices for essential goods and services.

Some people were still estimated to be up to £112 a year worse off, the report said.

Young workers

The committee found most of those affected were younger workers on low incomes with no children, but the worst-hit group were women between the ages of 60 and 64 with small work pensions.

Committee chairman John McFall said: “The government’s short-term priority must be to make every effort to compensate these people in full.

“The government must not let this issue slide into the background and will need to produce fresh proposals to fully compensate these 1.1m households by the time of the 2008 pre-Budget report.”

The MPs noted the government had yet to make clear whether the package of help given this year – funded by extra state borrowing – would be repeated in the future.

However, any new measures to help those losing out should be made through the tax system, the report suggested.

Child poverty

Frank Field, the Labour backbencher who led the rebellion against the scrapping of the 10p tax rate, said the government’s compensation package was not equal to one million people’s loss.

He said: “We will be looking, when we debate this in the Commons, and when the government promises it will come back in November, for a proper settlement for everyone who lost out on 10p.”

The committee called on Mr Darling to use his autumn pre-Budget report to launch consultations on future changes to income tax, rather than keeping them secret until Budget day.

“The government must now ensure that there is no backsliding and that future reforms to the tax and benefit system do not reverse this very positive development,” said Mr McFall.

The MPs also warned that the immediate need to compensate those who lost out after the scrapping of the 10p tax rate should not detract from the challenge of tackling child and pensioner poverty.

The report called for the creation of a Poverty Commission to look at the effect of public policy on the poorest families.

The decision to scrap the 10p tax rate, made by Gordon Brown in his last Budget as chancellor, came into force in April this year – alongside a reduction in the basic rate of tax from 22% to 20%.

It had threatened to provoke a backbench rebellion by Labour MPs

News reported by BBC