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Inflation is well above target - and well above where the Bank of England and others expected it to be not very long ago. That much we know. The big question is: should we worry?

Two different events this week seemed to suggest we should. The Organisation for Economic Co-operation and Development said in its latest economic outlook that the UK authorities, almost alone among the OECD, needed to be wary of losing their credibility on inflation. It even gave the Bank of England some free advice - to raise the bank rate to 3.5% by the end of 2011, starting "no later than" the last three months of this year.

The remarks were interesting because (a) the OECD doesn't usually give such specific advice to anyone, let alone to central banks; and (b) the text of OECD reports is always circulated well in advance to the countries concerned. This means someone at the Treasury was happy to see all this appear in print.

The other event was the release of the third estimate for UK economic growth in the first quarter of 2010. As expected, this was revised up slightly, to 0.3%. But the stand-out statistic on GDP wasn't the real figure - it was the nominal. These figures showed nominal GDP - the cash value of all transactions across the economy - growing by 2.1% during the quarter, or an annual rate of more than 8%.

The implication is that the GDP deflator - a measure of economy-wide inflation - rose by more than 1.7% in that period. That is partly due to the rise in VAT in January - but not entirely. Excluding taxes, prices across the economy rose 1.2% on the quarter, up from 1% in the fourth quarter of 2009 and 0.8% in the quarter before that.

The simplest explanation of these figures is also the most favourable to the Bank of England: quantitative easing worked. Just as the Monetary Policy Committee intended, pumping all that liquidity into the economy seems to have helped maintain nominal spending across the economy in the second half of 2009, even while the economy and the supply of bank credit were continuing to shrink.

But, as I have said in the past, there is still the lurking worry that coming out of this recession the UK could find itself getting less growth bang for every buck of nominal demand. To put it another way: the fear is that the balance between growth and inflation will turn out to be less favourable than before, and the Bank of England will need to put the brakes on the recovery sooner than it or anyone else had hoped.

For MPC members of a nervous disposition, it is not reassuring that the Bank - and so many independent city forecasters - have been getting their inflation forecasts wrong.

After all, they knew about the VAT change. They also, clearly, knew about the fall in sterling. These were incorporated in their forecasts, as was - at least partly - the rise in the price of energy. Yet still they were wrong.

More troubling, perhaps, inflation expectations are starting to drift up. Not massively. But worriers could definitely spot a trend.

The City, in general, still seems fairly relaxed. For all the muttering about the "Bank losing its grip", you're not seeing a big rise in City inflation forecasts, whether in the economists' formal predictions or embedded in the price of indexed gilts.

The relaxed school has plenty of big arguments on its side. For example: if you strip out the effect of tax changes, the annual rise in the consumer price index to April was much lower: 1.9%. If you also strip out energy prices, it was 1.4%.

Even if inflation expectations are ticking up, there's also little sign that workers are extracting higher pay rises. As Graham Turner, of GFC Economics, points out, IDS data for the three months to March show nearly a third (31%) of pay settlements involved a wage freeze.

More generally, it is clear that fiscal policy in the UK over the next few years is going to be sharply contractionary - rather more than the previous government had planned. The government is going to be contributing much less to overall demand, and keeping a tight grip on public-sector pay.

It is difficult to see how this feeds into a lot of domestically-generated inflation. But the big lesson of the past few years is that domestically-generated inflation is not necessarily the big concern.

Remember it was global food and energy price rises that pushed inflation up to 5.2% in September 2008, leaving some members of the MPC still talking about needing to raise UK interest rates, just weeks before Lehman Brothers went bust.

Today's high inflation doesn't necessarily tell us much about what inflation will be tomorrow. But it does bring home two deep - and somewhat uncomfortable - truths about the global economy and Britain's place in it.

One is that "re-balancing" - learning to sell more to the rest of the world - is no free lunch.

There is much rejoicing that we are not in the euro: and rightly so. It means we can use a cheaper currency to price ourselves back into the global market. But to boost our international selling power - and the competitiveness of UK workers - our purchasing power has to take a hit. Prices go up, but wages must not. Or not as fast.

Coming out of this process, our companies should be more internationally competitive. But we shouldn't delude ourselves: the pound in our pocket will be worth less. We will not be able to buy as much with it as we did before. Indeed, not buying as much as before is rather the point.

The other big truth about the world today is that in many global commodity markets we are not price-makers anymore - we are price-takers.

In the old days, demand from advanced countries like the UK used to set the price of steel, oil, food and the rest. Now - not so much. Now, demand from the emerging economies can play an equally large role - especially since their growth is more commodity-intensive; look at China.

HSBC's Chief Global Economist Stephen King spells out in more detail what this shift in global economic power could mean to all of us, in his scary but excellent new book, Losing Control.

In the meantime, we can comfort ourselves that domestic inflation is still - more or less - under the Bank of England's control. Even in a globalised world, the bank can still, in the end, control the amount of money flowing through the economy, which means it can stop inflation taking off as well.

But the Bank of England can't make the path out of this crisis an easy one. And it can't reimburse us for all that we have lost. Quite the opposite: it has to make sure that all of us - collectively - take a hit.

George Osborne has declared it the "fastest and most collegiate spending review in recent history." We'll see by the end of the day how collegiate the rest of Whitehall is feeling. Usually, within hours, we in the media would be given juicy examples of innocent victims and programmes who are going to be "cruelly hit".

But this is not a common-or-garden Whitehall pruning exercise. It is the first round in what is going to be a long - and painful - game. Staff may well want to save their hard-luck stories for later on, when they really need them.

The chancellor and his chief secretary will be pleased that they are in a position to "protect" schools and Sure Start and 16-19 year old spending from net cuts.

Given that the Conservatives were already protecting the NHS, defence and international development, it was always surprising that schools had been left out. Especially when the Tories wanted their schools reform plans to be up and running this year.

But note that the chancellor is still looking to cut the schools budget by £670m.For the department as a whole, that represents only a 1.3% cut in current spending - when others are having to find cuts of 3 or 4%. But when you take out core spending on schools, Sure Start and 16-19-year-olds, there isn't a lot of education spending left. Local authority grants for education are going to be cut, and so will spending on higher education, even allowing for that £50m additional investment in further education colleges that was announced at the same time.

Other points to note:

A large share of the cuts - at least half - will come not from civil servants but directly out of the pockets of private sector contractors. For example, the Treasury is expecting to save £1.7bn on delaying, stopping or renegotiating private sector contracts. There will be almost as much coming out of consulting contracts, IT and other spending.

As I've discussed in the past, the Labour government's own efficiency advisers - some, like Sir Peter Gershon, now helping the coalition - thought that re-negotiating contracts was an area ripe for savings - but not necessarily this year. It will be interesting to see whether the private companies concerned cry foul - or whether they, too, decide to hold their fire for the future.

As the chancellor admitted, local government spending has also taken a big hit. More than £1.1bn of the total savings will come from cutting grants to local authorities. This is another result of the decision to ring-fence large areas such as defence, international development and health. It's good politics for the chancellor to de-ring-fence £1.7bn in local government spending this year, to give authorities more freedom to cut. But I doubt that will be enough to silence complaints.

Should international investors worry less about the euro?

The voice for calm would say yes. True, financial markets have been spooked this week by aggressive German rhetoric - and action - against speculators. But it's hardly news that European governments want to rein in the financial system in key respects over the next few years. And, as , the Europeans aren't the only ones.

Look through the German rhetoric - the voice for calm would say - and you see the key player in the eurozone drama demonstrating that it is willing to put the future of the single currency before pretty much anything else.

The 440bn-euro special stabilisation mechanism for the euro has won support today in the German parliament.

Now assume that Eurozone finance ministers is able to give the markets enough details about that special vehicle for bailing out eurozone governments in the next week or two that investors can start to believe it really exists.

(OK, so the Eurogroup meeting to sign off on the details was cancelled today - because they, er, didn't have enough details to sign off. But assume they get their act together fairly soon.)

Assume - in other words - that the key pieces of the extraordinary support package for the euro agreed just under two weeks ago are soon in place. Then, in the short term at least, it's not clear why global investors need to worry a lot about the euro.

The Greek support programme means that the Greek government won't need to borrow money from the markets for well over two years. Markets can fret about them defaulting or restructuring their debt after that, but those doubts need not have much effect on Greece itself.

Likewise, if you were worried about Portuguese, Greek or Spanish debt sitting on bank balance sheets that they might find hard to sell - in theory, you don't have to worry about that any more. The banks have a buyer of last resort in the form of the ECB.

And if you're worried about other governments getting into trouble - well, there's a 750bn-euro support programme (the eurozone money plus the money from the EU and the IMF) as a third lind of defence.

With all these fortifications in place, it's difficult to see how you would get the kind of panic in the inter-bank markets which so rocked world markets in 2008 - and which we got another whiff of in the lead-up to those momentous negotiations earlier in the month.

Here endeth the lesson from the voice of calm. But, as I've been saying since the Greek crisis first began, all of this still leaves the central problem at the heart of the euro's troubles - which all of these frantic negotiations have not even started to resolve.

I write this from Brussels. Today's special taskforce meeting of European finance ministers is supposed to look at how governments could better co-ordinate their policies in the future - in effect, how the eurozone could behave more like a single currency area and less like a group of divergent states.

As we know, Germany is most focussed on the fiscal piece of this - tougher controls on national budgets. That is top of the agenda this afternoon. But I'm at a briefing by senior Commission staff involved with the meeting, and they say that "national competitiveness issues" - and "internal imbalances" - will also be discussed.

That's code for the fact that Germany and the Netherlands, in effect, have been playing China all these years while Portugal and the rest have played the role of the US. In other words: those North European powerhouses have been running up huge trade surpluses, while the Southern Europeans have run bigger and bigger trade deficits.

Whenever Germany tells you how much the Greeks are costing them, remember this: German exports to Greece have risen by 133% since the single currency started. Greek exports to Germany have risen by 13%. The resulting trade gap between the two countries is one reason why German banks are now sitting on so much Greek debt.

Portugal's current account gap was nearly 10% in 2009, only just below the Greek one. The Spanish current deficit was 5.3% of GDP.

These gaps have been hiding in plain view for years. But for all the talk about convergence, and "growth and stability", the Commission - and the leading eurozone governments - decided to turn a blind eye. The argument was that these deficits didn't matter - because they were caused by private-sector borrowing, not governments.

This is what Lord Lawson said in the late-1980s boom, when asked whether we should we be worried about Britain's gaping current account gap. It's also what Thailand said in the late 1990s. They were wrong. And so was the European Commission.

In the end, these imbalances always come home to roost - the private-sector bubble that was causing them bursts, and one way or another the borrowing is shifted onto the public sector. And governments have to do a lot of painful things to bring it down.

In Britain's case, and Thailand's, devaluation was the route back to competitiveness for the private-sector economy. As we know, that route is not open to the likes of Spain. And if Germany won't allow German inflation to rise above 2% (which it won't), these countries will need years of falling prices - and possibly shrinking nominal GDP - to climb their way out.

Germany is very much in favour of this kind of "convergence plan". It is not interested in making it easier - through higher German inflation, or higher German domestic demand, or higher German public borrowing.

So - with the best will in the world - this "better co-ordination process" being discussed today looks set to be an exercise in co-ordinated drudgery for large parts of the eurozone. And there will be another large part of the global economy looking to the rest of the world to provide its growth.

That is a pretty nightmarish scenario for the voice of panic to focus on.

The received wisdom, of the calming variety - says that even if it's bad, it's a slow-burn. There's no reason to panic today. But, looking at the market movements of the past few weeks, I'm not so sure.

Even if markets are not as efficient as the boom-time economic theorising proclaimed, they do have a way of turning bad news tomorrow into bad news today.

As we discovered yesterday, fears of a double-dip recession in the US have not entirely gone away, even if they are greatly reduced.

For many investors, the prospect of there being little or no European domestic demand to fuel US growth is not a pleasing one.

Slower future growth in the eurozone also means lower European stock prices today. And that is if the citizens of these countries actually allow the drudgery scenario to unfold. Investors might well start to wonder whether people will.

Remember that the grand stabilisation mechanism will offer no comfort to governments in search of an easier life. The whole idea of this mechanism, we are frequently and openly told, is that the conditions for getting the money will be so tough, no country will ever want to come to it for help.

It's true that Japan has gone through well over a decade of meagre, export-driven growth and falling prices - without riots, and without revolution. Maybe some version of that future is politically do-able for southern countries of the eurozone.

As I reported in early April, Ireland has taken its deflationary medicine surprisingly well. But I'm not sure that Spain and Portugal remind me of Japan.

I think I still believe in the voice of calm. But I find myself hoping that, this time, the markets are as short-termist as the critics suggest. If investors start to think too hard about the long-term picture for the eurozone, we could be in for some very bumpy times indeed.

Berlin: "Germany's lost the plot: it's rushing ahead on banning speculation, and now it wants other countries to go along."

This has been the widespread reading of what the German regulator did yesterday.

I write this from Berlin, and I can tell you that this summary is completely wrong.

For starters, the German government has not lost the plot - it merely wants to rewrite it to reflect German political realities.

German officials are under no illusions. They know that a unilateral ban on these trades - just in Germany - will not make much difference to anything.

They also know that other countries are unlikely to follow them anytime soon. They are not really asking them to.

I'm sitting in the Finance Ministry, at their G20 conference on reforming financial regulation. The finance minister hosted a dinner last night for the delegates, and I'm told that the German officials present were a bit sheepish about yesterday's ban.

They were also privately furious at Bafin, the German regulator, for allowing news of the ban to leak on Tuesday, before the Germans had been able to brief other governments.

So yes, that part of the German move was cock-up, not conspiracy. Officials had wanted to explain the move in advance.

Germany does want to see longer term reforms in this area - it is pressing the European Commission to put forward a draft directive that would take a serious look at some of these trades.

To be clear, as Robert Peston notes today, naked trading of sovereign credit default swaps doesn't have a lot of fans in official circles right now. Even if no-one thinks they have contributed much to the euro's troubles.

But this move isn't about that kind of longer term reform. It's about getting the 440bn euros special vehicle for supporting eurozone governments through the German parliament.

The key vote happens tomorrow. That is why we are seeing more of Chancellor Merkel today than originally planned. She's giving a last-minute speech to parliament later as well.

As I said on Today this morning, she needs to make this a crisis about "who runs Europe - governments or the markets?" If it is about whether or not to bail out profligate Southern Europeans, she will fail.

So, yes, it might have increased instability in the short run - witness what happened to European stocks yesterday.

But the German government's argument to officials in the US, the UK, and elsewhere has been that this ban will actually be a net positive for the markets - in the end - if it helps Germany get that support package through.

It's a pretty roundabout argument. But who knows? They might be right.

Certainly, investors are going to lose patience with eurozone governments quite soon if they don't get more details on how this massive support programme is going to work.

If this helps that move forward, it will help the eurozone, at least in the short-term.

Tomorrow the European governments - all 27 of them - will start work on the macroeconomic co-ordination side of the package, a discussion which, once again, the Germans plan to dominate.

The UK is not going to get dragged into anything it doesn't want to get into. But we will be there.

Be in no doubt: in return for signing-off on this rescue package, Germany will want the new rules of the road to be written in Germany's own image.

Chancellor Merkel has just alluded to this in her speech here - Germany wants tough fiscal controls for every eurozone country to come out of this. And, as one official said to me, at times like this, what Germany wants, Germany tends to get.

But outside Germany, the worry is that the big losers in all this won't be speculators - but ordinary citizens in countries like Spain and Portugal who find they cannot combine massive budget cuts with decent economic growth.

Make no mistake, the UK and the rest of the world will suffer as well, if the conclusion of this crisis is a eurozone based on the same export-led growth model as Germany.

The rest of the world needs domestic demand in the eurozone to grow, not shrink even further, in the next few years. But right now it is very difficult to see how that will happen.

Indeed, if Germany has its way, the eurozone is going to make an even smaller contribution to future global growth than we thought.

Sometimes a picture is worth 1,000 words. Here's what's happened to inflation recently in Britain - and the eurozone.

Attending his first meeting with other European finance ministers today, George Osborne might reflect that inflation is yet another area where the view from the UK is rather different.

I've spoken before about UK inflation and its recent tendency to surprise on the upside. As the latest Bank of England Inflation Report admitted, inflation has been above the 2% target in "all but six of the past 30 months".

It may indeed be almost entirely due to temporary factors, which the Bank would be foolish to respond to. But as Mervyn King noted in his press conference releasing that report, it is not enough that this argument is right - it has to be seen to be right by investors, and by the public at large.

As I said in that earlier post, every percentage point rise in the cash value of our economy makes it a little easier for the government to bring down borrowing as a share of GDP.

Tax revenues go up, even if real growth has not - and fixed spending totals end up looking smaller, both in real terms and relative to the overall economy.

Of course, the reverse is also true. Low inflation is another reason why many eurozone governments have found it so hard to reduce their borrowing and debt.

So, it is a convenient coincidence for the UK that inflation is overshooting, just as government borrowing is at its peak. It is also not entirely unrelated - after all, our fiscal plight is one reason why the pound has fallen so sharply, and why prices of imported goods have gone up.

I know even the use of the word "coincidence" will send some of my regular correspondents rushing to their keyboards, outraged, once again at my naivete. In their view, this all part of the authorities' cunning plan to inflate away the debt.

To be clear: I don't think there is such a plan. Cunning or otherwise.

Mervyn King once again last week said last week that he thought inflation would fall back next year, which would imply that interest rates would stay low for a long time - even as growth starts to pick up.

Apparently, the majority of investors still think that's the most likely outcome. Money market rates didn't rise in response to today's inflation news.

However, it's not nothing that the older, RPI, measure of inflation is now at 5.3% - the highest in nearly 20 years.

Whatever the truth, sooner or later, the risk is that the City will decide that the Bank has gone soft on inflation after all.

It's democracy: but not as we know it. That's been many people's dazed response to the advent of coalition politics in the UK.

One minute British politics was a battle of competing tribes - the next we had two terribly nice chaps in the garden of No 10, united by their desire to "do the right thing".

For some it will feel like the heart has been sucked out of government. For those of a more technocratic bent, it will be about time. Finally, they will say, we can strip away the fancy ideology and get down to what actually works.

I suspect that many people will feel both: relieved if it means less yah-boo politics, but also disconcerted about where it will lead.

Funnily enough, for anyone wondering what to make of the new politics, the creation today of the Office for Budget Responsibility (OBR) could be an interesting test.

It's no accident that the creation of the OBR will be one of the first acts of this new administration - like Gordon Brown's (then) shocking decision to make the Bank of England independent in the early days of the new Labour government in May 1997.

As a voluntary surrender of executive power, the OBR does not (quite) rank alongside that transfer of power to the Bank. As Mr Osborne has himself said, the analogy is inexact because you can't give an unelected body "independent executive power over the levers of fiscal policy."

The OBR will not set tax rates like the Bank of England sets the bank rate on which every other interest rate in the economy is based.

But make no mistake: like an independent Bank of England, this new institution has the potential to become a hugely powerful force. It will not set the rate of VAT - or spending on the NHS.

But when it comes to budget policy, this government is going to be on a much shorter leash than the one that came before.

Last week we discovered that the new chancellor had, in effect, asked the governor of the Bank of England's permission to go ahead with his plans to cut public spending this year.

Mr Osborne has said all along that he would seek Mervyn King's advice in setting his policy. Once he had got the thumbs up, on Tuesday, the chancellor was keen that the governor should tell us what he thought in his Inflation Report press conference the following day.

, this was something new. Was it welcome? Again, those of a technocratic bent would say yes. It's been a long time since monetary and fiscal policy were so mutually interdependent. Now more than ever, each lever of macroeconomic policy needs to know exactly what the other is doing.

Then again, no-one ever voted to put Mervyn King in his current post. If last week had not been so full of historic firsts, you might have heard more people questioning whether he should have played such a key role in making this hugely important political call.

We are told that this was a one-off. The governor does not plan to give a running commentary of British fiscal policy. But that is exactly what the new OBR will do.

At least twice a year, this unelected three person body, with its own staff, will publish independent fiscal forecasts around the time of the Budget and pre-Budget report.

Like the Bank, it will be given the government's medium -term target (in this case, for the budget deficit - or surplus rather than inflation). On the basis of its independent forecast, it will then recommend how much policy needs to be tightened or loosened to have a decent chance of meeting that goal.

Yes, the chancellor can ignore this advice. But the point of the exercise is that politically this will be very difficult to do.

Many in the Treasury are nervous of the new regime. Supporters of the OBR will say they have no-one to blame but themselves - or at least their old masters.

The macroeconomic forecasts under Labour were not as bad as they were cracked up to be (in fact they were often better than City predictions). But the revenue and borrowing forecasts in the latter years of the Labour government were objectively atrocious.

The likes of the National Institute of Economic and Social Research and the Institute for Fiscal Studies said they were optimistic at the time - but no-one knew quite how far off the mark they would turn out to be.

True, the financial crisis was exceptional - causing a collapse in revenues from the City that few could have predicted. But tax revenues were being consistently overestimated by Gordon Brown's Treasury, long before Northern Rock.

In the old days, politicians weren't very good at setting interest rates either. This didn't matter so much when inflation was not very high. But in the 1970s and 1980s, it became very important indeed.

Around the world, central banks started to get the power to run monetary policy for themselves. This was not just because they were outside politics, but because the belief they were outside politics actually made it easier for them to do their job: popular expectations of inflation were more likely to stay low.

That is and was a real and tangible benefit to Bank of England independence that Mervyn King is understandably keen to retain.

Now the deficit is public enemy number one, and once again, the argument is that things will be better for everyone - including the elected government - if its freedom of manoeuvre is more tightly constrained.

That is why independent experts like the IFS have cautiously welcomed the idea of an OBR, though they think the details will need to be carefully worked out. But even the greatest fans of this new institution may still stop to ponder what has been lost - and what has been gained.

As with monetary policy, it is possible that the mere fact of being independent will make the OBR's job easier than it was in the past. The long-term cost of servicing the public debt could now be lower, because investors know there is a highly visible independent body overseeing the books.

But the world has not had an enormous amount of experience of these bodies. It is less clear than in the case of monetary policy what the government is getting for its loss of control.

Yes, the OBR will not be politically motivated - or not in the same way as the Treasury might have been in the past. But - as any glance at the record of other forecasters will show - that is no guarantee that they will be right.

The Liberal Democrats may have swallowed some extra spending cuts, but the Conservatives have taken on a lot of Lib Dem tax policies in return.

That's the first conclusion to draw from the seven page agreement between the two parties that's just been published.

It's not just the commitment to raise the income tax threshold to £10,000, though that is probably the biggest concession. My colleaue, Hugh Pym has confirmed that the government will make a start toward this in April 2011, by raising the allowance by £1,000.

This would cost around £5bn. As I revealed last night, this will partly be paid for by not implementing the Conservative plan to raise the employee threshold for National Insurance. The remainder will come from raising capital gains tax for individuals.

The increase in capital gains tax rates is another Lib Dem proposal which the Conservatives opposed on the campaign, on the grounds that it would stifle risk-taking and innovation. In a nod to this, the document says there will be "generous exceptions for entrepreneurial activities".

But it's hard to believe they will be that generous, when the Conservatives are apparently seeking to raise rather more from this source than the Liberal Democrats were - about £2.5bn, rather than the £1.9bn anticipated by the Lib Dems.

(Interestingly, on the campaign the IFS had concluded these changes would raise more than the Liberal Democrats thought.)

Here are some of the other areas where the Lib Dems have got their way on tax: there will be a per-plane, rather than per-passenger tax on air travel - again, with any extra proceeds to go into raising the personal allowance.

There will also be "detailed development" of the Liberal Democrat proposals to raise money by tackling tax avoidance - another proposal that was much derided by George Osborne and others on the campaign trail.

As I reported last night, the Tories have not abandoned the plan to reward marriage in the tax code. But even here, the Liberal Democrats have not had to cede much ground - their MPs can abstain when it comes before Parliament.

The inheritance tax cut is in the long grass, well down the pecking order for tax cuts, in a parliament which is unlikely to provide room for many.

Intriguingly, there is no mention at all of the 50p top rate of income tax. Up until now, getting rid of that had been, in effect, the Tories' number two tax priority, after avoiding the so-called "jobs tax", though they weren't going to do anything about it while public sector pay was being cut in real terms.

You have to wonder whether that's been kicked into the long grass as well - especially when every spare pound of revenue is apparently going to be channelled into that hugely expensive commitment on the tax free allowance.

The Liberal Democrats aren't going to get their "mansion tax". And Britain won't be preparing to join the euro any time soon. But, looking at events across the Channel, I suspect they will be able to keep their disappointment firmly under control.

Supposedly, the package won't cost any more than the Conservatives' previous tax and spending plans. However, it seems that some of the £6bn in spending cuts this year will, in effect, be used for targeted tax cuts to support jobs (the example given is the cancellation of "backdated demands for business rates.")

Presumably the cost of that will be met partly by the change in the National Insurance plans.

However, the deal has once again narrowed the new government's room for manoeuvre on spending cuts.

Remember going into this election, the Lib Dems didn't want to protect the NHS from real cuts in spending, and the Tories didn't want to protect the schools budget. Now, in effect, the government is committed to achieving real terms growth in both schools and NHS spending.

The Tories have agreed to fund a significant "pupil premium" for disadvantaged pupils from outside the schools budget, by finding spending cuts elsewhere - but they have stuck to their promise to raise NHS spending in real terms.

All this, against the backdrop of a resounding thumbs up for the deficit plans from Mervyn King this morning. More on that later.

I have learned that the Conservatives will not implement a key part of their National Insurance tax cut next year, in order to make a start on raising the main income tax threshold to £10,000 a year.

Confirming what Robert Peston reported earlier, the Conservatives have indeed taken on this Liberal Democrat pledge as a priority on tax for a Conservative-Lib Dem coalition. This is how they plan to show they are in good faith.

Remember that Labour has put in train a rise in both employer and employee National Insurance from next year. This tax rise was always going to go ahead under the Conservatives. But to prevent it from affecting most taxpayers, they had pledged to raise the threshold at which both employers and employees pay national insurance.

Now, as part of the agreement with the Liberal Democrats, they are going to only raise the employers' threshold - and use the money saved to raise the basic income tax threshold instead.

I'm told that this increase in the allowance will be significant, costing more than the rise in the employee threshold which it replaces - though nothing like the nearly £17bn it would cost to go all the way to £10,000. They will need to raise money from somewhere else as well, but the bulk of the money will come from not implementing that piece of their national insurance cut.

For many taxpayers, the difference will be fairly academic. True, pensioners who earn more than the current income tax threshold but don't pay national insurance will benefit more from the income tax change. But their income tax allowance is high already, so it won't be big money.

But clearly, this was an important symbolic concession for the Liberal Democrats.

Contrary to some reports, I am told that the Conservatives have stuck to their guns on the modest tax cut for married couples in the Tory manifesto, but the inheritance tax cut is indeed firmly on the back burner .

As previously indicated, the Tories have stuck to their guns on the commitment to cut public spending by at least £6bn more than Labour was planning in 2010-11 - my sense is that it could end up being more than that.

They never seriously contemplated rowing back on this crucial part of their USP for the financial markets. But there has been some form of assurance that the cut will not go ahead in full, if the economy drastically weakens in the next few months.

Vince Cable can draw comfort from this, and perhaps even more from today's encouraging news about manufacturing output.

As a result of the new output figures for March, the first estimate for growth in the first three months of 2010 is likely to be revised up. Indeed, for all the talk, this recovery is starting to look rather like past rebounds.

We might have hoped for something better, after an unusually steep downturn, but the news is reassuring all the same. In terms of rhetoric, it will help the Liberal Democrats make the case that a £6bn additional spending cut may not be, er, quite as cataclysmic as previously claimed.

Come to think of it, I guess Vince Cable will also have to rethink his scathing assessment of the Conservatives' promise to find an extra £12bn in efficiency savings this year. But something tells me that won't be the greatest piece of fancy footwork demanded of him and his Liberal Democrat colleagues in the weeks to come.

Now we wait to hear what the Governor of the Bank of England decides to say - and not say - about all this at his press conference tomorrow morning.

It's official: the future of the eurozone is more important than Nick Clegg. Along with other markets, the FTSE has soared on the back of the deal agreed by European officials early this morning, and for good reason.

If we are to take this package at face value, the rules of European Monetary Union have been fundamentally re-written. For governments, being in the eurozone means something very different today than it did just a few weeks ago.

As we have seen, the role and responsibilities of the European Central Bank (ECB) have changed radically as well.

If this deal is what it is cracked up to be, countries like Germany may have to fundamentally change the way they think about monetary union - and, ultimately, the way they think about economic growth as well.

However, it is not clear that the tired officials who came up with this deal early this morning have really thought that far ahead.

It has all the hallmarks of what American football fans would call a "Hail Mary pass". It looks impressive, and it buys the Europeans some crucial time. But they may not like where the ball eventually ends up.

Looking across European markets - it's clear that last night's 750bn euros package to shore up the euro has already done something important: it's changed the narrative of the crisis.

The story for months has been that the eurozone governments were behind the markets. Shortly after 0100 BST, they finally got out in front - and, crucially, so did the ECB.

But there are some important questions still to be answered: especially about the 440bn euros "Special Purpose Vehicle" for eurozone countries in trouble which is really the only novel part of the programme.

The 250bn euros from the IMF has been there all along: the IMF Managing Director, Dominique Strauss-Kahn, merely did the Europeans the favour, this weekend, of reminding them that it could be re-described in the interests of some market "shock and awe".

We don't know much about how the Eurozone special vehicle would work. Truth be told, eurozone officials don't either. After all, yesterday morning, it wasn't even a thought in their heads - let alone a plan.

When eurozone officials went to bed on Saturday, the 60bn euros souped-up European Commission lending facility was the only concrete proposal on the table.

Only after a lot of urgent re-education by American, British and Japanese officials did the eurozone reluctantly come to the view that they needed more. A lot more.

So, yes, the lack of fine print is understandable. But if there's any lesson of the past few months is they need to sort it out, fast. Investors are going to have plenty of questions about how the vehicle would work, what kind of seniority it would have with regard to other debt, and so on and so on.

If officials can't answer these questions fairly soon, with a clear timetable for how each parliament will do its part, the honeymoon in the markets will be short indeed.

Of course, the biggest short-term question is how the Germans will square this with their Constitutional Court - not to mention German voters.

On the face of it, this agreement is at odds with the Court's 1993 judgment on the Maastricht Treaty, which said that stability is an "unalienable basis for Germany's participation in a monetary union".

Any violation of this principle would undermine the legal basis for Germany joining the euro in the first place. Arguably, the No Bail-Out clause of the Lisbon Treaty was one of the key pillars of the system.

Over the weekend, the Court refused to issue an injunction against the German piece of the Greek support programme, endorsing Chancellor Merkel's view that delaying the deal now would be too costly.

But it could still find the Greek package unconstitutional, on the basis of a legal challenge that has been brought by five German academics. On the face of it, the creation of a gigantic new vehicle for bailout out governments looks even more problematic.

Here's the obvious Catch 22 for Chancellor Merkel: if this commitment to safeguard the euro is real, then the eurozone countries - including Germany - now stand behind a significant part of eurozone government debt.

The Court might well judge that to be inconsistent with the terms on which Germany entered EMU. But if Chancellor Merkel insists that it doesn't mean that, that Germany's fiscal sovereignty has been retained - then clearly investors will ask what that 440bn euros really means.

As I suggested last week - one test of all this will be what happens to bond market spreads within the eurozone over the next few weeks and months.

If the core countries have now taken on a collective commitment to stand by a good chunk of eurozone sovereign debt, you would expect, not just Greek yields to go down, but German yields to go up. We shall see.

Clearly, there is plenty that could go wrong in the next few days and weeks. Investors will also need to hear more from Spain and Portugal about how they are going to further squeeze their budgets. Both governments fought against it over the weekend, but there will be announcements in the next few days.

But assume (and it is a brave assumption) that the package survives the scrutiny of the markets over the next few weeks. There is an even bigger question hanging over the package.

Put simply: it tackles the symptom of the problem, by making it easier for the high borrowing countries in the eurozone to pay their bills.

By itself, the deal doesn't materially change the amount that eurozone governments will have to borrow over the next few years. And it doesn't even begin to talk about addressing the reasons why countries like Portugal are borrowing so much in the first place.

Indeed, by promising more fiscal action, across the zone, it actually makes it worse, by making their growth prospects even weaker than they were before.

I will have more to say on that, and on the ECB piece of the package, in a later post.

Update, 16:50: A few numbers to throw light on my earlier comments. The new 440bn euros firewall for eurozone governments would amount to about 6% of outstanding eurozone government debt, which was just over seven trillion euros in 2009. Throw in the 80bn euros promised separately to Greece, and you're talking about 7.5%.

So, the Germans could reasonably argue that this special vehicle is far from a blanket guarantee of the eurozone's debt. But, arguably, on this occasion, the flow matters more than the stock. And the principle matters most of all.

Collectively the eurozone countries borrowed 565bn euros last year. So, in a few short weeks, these government have collectively agreed potentially to underwrite nearly a full year's borrowing. The implicit guarantee for the countries that are likely to be affected by the deal is much bigger: after all, the entire Portuguese deficit last year was 15bn euros. Spain's was 118bn.

That is getting very close to a fiscal union, at least in terms of the implicit liability for core members like Germany over the next few years. Whether they will be getting a more stable eurozone economy in return for that new liability is still today an open question.

Like the rest of us, investors are in wait and see mode. If it happens, and that is a big if - the debate will turn to what kind of budget a Conservative minority government could get the Liberal Democrats to support.

Traders sold the pound this morning; it has now lost several cents against the dollar. But with so many other countries also under pressure, there's a shortage of currencies to fall against.

On a trade weighted basis, the pound has not been badly hit today, though of course it has fallen plenty this year.

As others have reported, gilt futures fell sharply overnight, and the FTSE fell sharply at the opening. But there's been no rout - in fact so far the FTSE is having a better day than many markets on the Continent.

The leading ratings agencies have all come out saying the election result will not change their immediate view of the UK - or threaten its AAA credit rating anytime soon. This, from one senior analyst at Moody's:

"Moody's stance assumes that the incoming economic team can muster convincing parliamentary support for a fiscal adjustment that is no looser nor slower than was outlined by all three political parties during their respective pre-election campaigns...The lack of a one-party majority will undoubtedly create political uncertainty in the short and perhaps also the medium to longer term. Nevertheless, Moody's view is that it is not the political but the policy outlook that matters most."

Establishing what, exactly that policy outlook will be is of course all that we will be talking about for the coming hours and days. Let me just throw down a few guide posts.

On two of the big economic issues of the election - when to cut borrowing and how much to raise taxes - the Liberal Democrats and Conservatives were on different sides.

The Conservatives wanted to cut spending this year - the Liberal Democrats said it was important to wait. The Conservatives went into the campaign promising a net tax cut - relative to labour. The Liberal Democrats promised a small tax rise.

This doesn't like fertile territory for a deal - tacit or otherwise.

But, luckily, "the big economic issues of the election" were not the big economic issues facing the country. The most important question for any international investor is whether the next British government will be committed to cutting the deficit.

On that question all three parties agree, and even on the details, the Liberal Democrats and the Tories are closer than you might think.

Both Vince Cable and George Osborne have said in the past that the government's deficit reduction plan was not ambitious enough.

And both have expressed a desire to limit tax rises on labour income - though the Liberal Democrats channelled this desire into radical tax reform for the lower paid, not delaying Labour's National Insurance rise.

You can, in short, see the outlines of a budget which the Liberal Democrats could support on the day: maybe £3bn in spending cuts this year instead of £6bn; maybe using the proceeds of the bank levy to pay for a targeted tax cut for the low-paid. The problem, for investors, would be what comes before that - and what comes after.

We don't yet know that the Tories will be in the Budget-writing business in a few weeks time. The question of political reform could stand in the way.

And even if they are, we can't know whether the Liberal Democrats will continue to support the Conservatives down the road, when the going gets tough and voters are feeling the effect of cuts.

These and other big question marks will hang on British assets for a while to come - even if investors today are giving us the benefit of a lot of doubt.

Update, 15:05: David Cameron's statement rather underscores what I was saying earlier - there are some important areas of agreement between him and the Liberal Democrats on the subject of the deficit.

As predicted, he's reminded Mr Clegg that they both agree on Labour's so-called "jobs tax". And he is willing to give ground on tax cuts for lower paid.

Others will pore over the political implications of what Mr Cameron has said. I doubt Mr Clegg will think an all-party committee on political reform is a good substitute for a referendum.

But note the mood music: as Mr Cameron said many times, this is a time where urgent things need to be done, and the British economy needs stability at the top. Subtitle: this is not a time to put Britain's political stability at risk over your own self-interest in electoral reform.

He said that the Conservatives had not changed their mind on cutting spending this year - but note there were no numbers involved. As I said earlier, the gap between zero spending cuts this year and net cuts of £6bn would surely not be too hard to bridge.

Even if it is not - remember spending cuts don't need a formal Parliamentary vote, only tax rises. That distinction is not lost on George Osborne.

The markets may well like the sound of Mr Cameron's offer - investors want him to find a stable working arrangement for government almost as much as he does himself. They and we will wait to see how it goes down with Nick Clegg.

The head of the European Central Bank once again said today that a Greek default "would not happen". Every G20 official - in or outside the eurozone - will tell you the same thing: with markets as fragile as they are, it is unthinkable that a sovereign government would be allowed to default. Investors and experts are thinking about it all the same.

In fact, looking at , many veterans of past debt crises would say a debt restructuring was only a matter of time. But it's worth asking how - and when - it is done. And how it would help.

As you'd expect, there's no rule book for countries seeking to default on their debt. It's not something the international system likes to encourage. But it's not as if it has never happened. There have been 40 defaults by sovereign governments in the past 20 years alone, and more than 70 since 1980.

Many of those governments were able to borrow again quite soon after - sometimes in a matter of months. But only when they were able to do a deal with all - or nearly all - the bond-holders on how much of the debt would get repaid - and over how long.

Russia took less than two years to restructure its foreign debt after declaring a moratorium in August 1998. Creditors lost about half of the value of the principal. A similar deal was done over the same period for Ukraine and its debt. But as we know, Argentina in January 2002 was different: messier and much more drawn-out. Offered only 30 cents on the dollar, some bond-holders are still holding out, eight years later. Only now is the country able to talk about borrowing again on international capital markets.

Research by IMF economists (The Costs of Sovereign Default, Working Paper October 2008) suggests the long-term cost of default for countries can be quite low: after a few years, governments don't even pay much of a premium on world markets. But the short-term cost to the economy can be huge. That would certainly apply to Greece today.

Imagine the Greek government stopped paying interest on its debt tomorrow. It would still have a primary deficit - excluding interest payments - of more than 8% of national income, and it might not have anyone to borrow that money from. That could mean more austerity, not less, especially if the country remained in the euro.

There would also be the collapse of the domestic banking system to consider, Greek banks being the largest holders of Greek sovereign debt. And that's before you get even to , as investors wondered who would be next.

Many investors now think a Greek default - or debt restructuring - is inevitable at some point. They may be right. But it's no soft option. There are good reasons why European officials will keep saying it is unthinkable for as long as they possibly can.

Our major political parties have disagreed on plenty over the past four weeks but they agree on this: economic growth could not be more important to Britain's future.

Put simply: growth is how we get out of this mess. Where they differ is over which strategy is most likely to secure it.

Even with a decent economic recovery, the next few years for the UK are not going to be easy. But without one, they could be extremely painful indeed, with a prolonged period of stagnation and probably a budget crisis as well. Just ask Greece.

As the European Commission's latest forecasts make clear, one of the biggest differences between Britain and the likes of Greece and Portugal is that we have a better chance of expanding our economy in cash terms than they do.

I suspect the Commission did not intend their latest report to be read as a Eurosceptic charter for the UK. But if you're looking for reasons to be glad Britain is not currently in the euro, it's a good place to start.

According to the Commission, Britain will have the largest budget deficit in the European Union in 2010 - at 12 % of GDP.

If they're right, only Ireland's deficit of 11.7% this year will come close (though I note they have raised their estimate of last year's Greek deficit yet again - to 13.6% of GDP).
Stripping away the effect of the recession, Portugal and Spain will both have smaller structural budget deficits, relative to their economy, than the UK in 2010.

Spain's stock of debt is smaller as well: general government gross debt is expected to rise to 72.5% of GDP in 2011, compared to 86.9% for the UK. Portugal's is higher, but not much - it's expected to rise to 91.1% in 2011.

So why is Spanish and Portuguese debt getting downgraded while Britain is not?
As I've discussed before, there are technical and historical factors that help: notably, the sheer depth of the gilts market and the high average maturity of our debt. But aside from those, the biggest plus point in our favour is growth.

A decent recovery for the UK is far from guaranteed. But regardless of who wins the election, some important building blocks are in place, and we have this week had encouraging signs that the manufacturing recovery - partly driven by exports - is gaining pace. The same cannot be said for Club Med.

The Commission has the Spanish economy continuing to shrink in 2010, with only 0.8% growth in 2011. Greece will shrink by 3% in 2010 and 0.5% next year.

The forecast for Portugal is positive in both years, but only just: a meagre 0.5% growth in 2010 and 0.7% in 2011.

By contrast, the forecast for the UK is for growth 1.2% in 2010 and 2.1% in 2011. That 2011 figure is much lower than the government's forecast, but it's quite a lot better than the average 1.5% forecast for the eurozone as a whole.

Crucially, our growth will also be higher in nominal terms because of higher inflation. If this fairly downbeat forecast is right, Britain's national income will grow by 3.7% in cash terms in 2010.

The average for the euro area will be 1.6%. The Commission expects inflation to fall back below target next year, and I assume the Bank of England hopes it will too.

But in the meantime, that 2% of GDP difference in cash-flow will be very welcome indeed to the Treasury. Remember tax revenues rise at least as fast as nominal GDP, whereas spending (and debt) is fixed in nominal terms.

The longer term forecast for the likes of Spain is not much better: indeed, when Standard & Poor's decided to downgrade Spanish debt again, they cited the worsening outlook for growth as the key factor.

As ever, the forecasts for the periphery are much bleaker than for the eurozone's "core".

I've discussed before that there's a more basic competitiveness issue lurking beneath the fiscal problems of Portugal, Greece and the rest (see my previous posts No more euro deja vu and Thinking the unthinkable).

What's depressing about the latest Commission report is that it has plenty to say about global imbalances and how these might be addressed - very little about the imbalances within the eurozone, which have helped put it where it is today.

Germany and the Netherlands are singled out as countries that are "well-placed" to benefit from the global recovery, with double-digit growth in exports over 2010-11.

They are also the only two countries expected to increase their share in world markets in both years.

There's plenty for Britain to worry about in these forecasts: the Commission doesn't forecast a big recovery for our exports by 2011. Fiscal tightening is also going to take its toll.

As in Portugal, Greece and Spain, government consumption is expected to fall next year, whereas for the euro area as a whole it is supposed to rise.

But our borrowing from the rest of the world is nothing like the level of these other countries - Portugal's current account deficit is expected to be 10% of GDP in 2010 and 2011 - even higher than for Greece. Britain's will be around 1.6%.

The enormous current account deficits we've seen on the periphery of the eurozone would simply not have happened without the single currency: either the currency or the economy of these countries would have had to adjust long before (probably both).

As we are seeing, they are not sustainable. But nor are they easy to fix. That is the fundamental problem facing these countries which fiscal austerity will not fix.

Britain has made its own mistakes over the past few years - and dug its own enormous fiscal hole. Looking ahead, there is also plenty that could go wrong.

If the recovery stumbles, for whatever reason, or the next government sends the wrong signals about the deficit, the ratings agencies will surely be sniffing around the Treasury's door as well. But you can't help reading the Commission's report and thinking it could be quite a lot a worse.

The Greek support package has failed to achieve its key objective. Investors have little more confidence in Greek debt than they had last week.

And - it seems - little confidence in the eurozone either. The euro today sank to a one year low, and markets shuddered across Europe.

Why? Apparently, even bond market vigilantes think you can ask a government to do too much.

The interest rate on two-year Greek debt has gone up nearly three percentage points since this morning. Worse, from a eurozone standpoint, Portuguese bond yields have risen sharply as well, though in Spain it's been the stock market rather than bond prices that have been taking the strain.

Assuming the support package goes through the various national parliaments, the huge new pot of official money should mean that Greece doesn't have to worry about borrowing from the markets for quite a while - these high interest rates need not affect it. But the likes of Portugal don't (yet) have that safety net.

To see what a disappointment this must be for the European authorities, consider quite how much precedent and procedure has been thrown overboard in the past few days.

Between them, eurozone governments have promised to lend Greece 80bn euros - despite a "no bail out clause" in the Maastricht treaty that was designed precisely with countries like Greece in mind.

The IMF is also on the peg for 30bn euros, even though that is more than 30 times Greece's quota at the IMF, and the most they have ever previously made available was 15 times quota.

And, also hugely significant, the European Central Bank (ECB) has agreed that European banks can put up any Greek government debt as collateral for cheap liquidity - despite the fact that the ECB's president had previously insisted there could be no change applying to one country alone.

But there are times when spelling out exactly how a country is going to be rescued only goes to remind everyone how much of a jam they are now in.

Even hard-nosed investors look at the austerity that comes with this programme and wonder how on earth a democratic government is going to stay the course. This isn't a short sharp shock, it's the macroeconomic equivalent of many years' hard labour.

Greece has to cut its budget deficit by 11% of GDP in three years - and most of that time its economy will be getting smaller, not bigger.

The Greek government was forecasting that growth would return in 2011 - and the budget deficit would fall to less than 6% of GDP. As the IMF has correctly identified, those two numbers were mutually incompatible for Greece.

The IMF-eurozone programme forecasts the economy will shrink by 2.6% next year, and borrowing will still be close to 8% of GDP, only falling below 3% of GDP in 2014.

But realistic is not the same as plausible. Looking at the programme, many economists expect that sooner or later, the Greek government will falter in meeting its commitments.

The IMF would then have to decide whether to suspend the programme and push the country into default - as it did, in effect, with Argentina. The eurozone governments would have to decide whether to let Greece renegotiate its debts after all.

Sovereign CDS spreads for Greece - a rough guide to market expectations of a default - are now over 730 basis points, higher than yesterday, or the end of last week (though somewhat below their peak of 824 points a week ago.)

Spreads for Spain and Portugal have risen by 30-40 basis points. Officials were probably hoping to see them go down.

There will be more to say on this in coming days - particularly on the ramifications for the balance sheets of European banks and of the ECB, where a good part of this crisis may now be played out.

But here's one interesting point to note about today: the interest rate on German government debt fell once again. You might say - what's so surprising about that? The answer is that it's not a surprise, but it does tell you that bond investors do not think that, in the end, Germany will put European integration ahead of its own monetary stability.

How so? This weekend, the eurozone - Germany at the forefront - effectively said they would underwrite Greek sovereign debt. This is how the distinguished as and when the contagion spreads to Portugal, Spain, and beyond:

"What has been offered to Greece cannot be refused to other eurozone governments. So, one more time, a (dwindling) group of deficit-stricken countries will have to provide money to increasingly large debtors. In fact, this process means that ultimately there is no national debt anymore, at least for the next few years. In effect, in the market eyes, there will then be just one eurozone debt. Could markets run on all eurozone public debts? Once again, no one would expect all eurozone governments to be forced to default but markets can and do panic and self-fulfilling crises can occur wherever there is vulnerability. Just imagine that, one by one, each eurozone country falls in the same trap as Greece. Eventually, Germany could be last one. Could it underwrite all the other public debts, on top of its already own respectable one? Current estimates set the overall eurozone public debt level at 90% of GDP in 2012. This is reassuringly lower than Greece's 135%, but it is about the same as Portugal's and it represents 330% of the German GDP."

Unsurprisingly, the markets are not pricing in this scenario quite yet. German debt is still considered a safe haven within the eurozone, even though it's Germany that could end up paying all the bills. Either investors cannot think this far ahead, or they think - probably rightly - that German voters would jump ship long before.