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Cheers and fears for Osborne's belt-tightening

Paul Ellis | AFP | Getty Images

The talk at the end of the second day of the annual conference of the U.K.'s governing Conservative party was all about Chancellor George Osborne and his belt-tightening pledge to get the country back into the black.

The gossip at the flurry of parties may have been about an appearance by the leader of rival anti-Europe party UKIP and a quip by London Mayor Boris Johnson that Prime Minister David Cameron was "not for kipping", but the UK Treasury chief's speech earlier in the day was in equal parts praised by the party faithful and pored over by economists and analysts.

The chancellor's big speech unveiled three government pledges:

  • A Help to Work scheme, where the long-term unemployed will be enrolled into community work schemes if they cannot find a job
  • A planned freeze on fuel duty - as long as Osborne can find the money.
  • And a new economic rule to bring public finances into a budget surplus.

The chancellor's new shorter haircut, together with his more confident style, impressed party pundits. His message was also short -- austerity had worked. The British economy was finally turning a corner after years of low or negative growth, and this was thanks to "grown-up" economic policy brought in by his government.

(Read more: George Osborne targets unemployed in speech)

However, just as markets flinched on fears an Italian government break up and a shutdown in Washington, Osborne made clear the battle for recovery was far from over.

The Conservative-led coalition government has introduced a raft of austerity measures to bring the country's finances back under control.

The fiscal handcuffs would stay firmly on for years to come, Osborne said Monday. And the harshest spending cuts would continue past 2018 in order to create the budget surplus. In fact, under the new plans, the government's total spending freeze could last a whole decade - from 2010-2020.

It's worth remembering that the public finances have only ever been in the black seven years out of the last 54 years -- leaving the chancellor with an uphill struggle.

Osborne's pledge sparked a debate whether this new fiscal rule was just a re-hashing of an old pledge.

Citigroup economist Michael Saunders interpreted it as simply being the existing target "of being on track for a cyclically adjusted current surplus (ie surplus ex investment) five years ahead."

(Read more: George Osborne renews backing for more banking competition)

Saunders added that if the Chancellor "truly intends to commit to achieve an overall fiscal surplus in the next parliament (ie 2015-20), as opposed to a cyclically adjusted current surplus, this will be a much tougher aim. At present, the OBR (Office for Budget Responsibility) project a fiscal deficit of 2.2% of GDP in 2017/18, their forecast horizon."

Saunders also pointed out that more significant might be the chancellor's pledge "to ensure capital spending grows at least in line with GDP."

According to the Budget projections, nominal gross domestic product (GDP that has not been adjusted for inflation) will rise by 18.1 percent between 2013/14 and 2017/18, while gross public sector investment will rise by 10.4 percent and net public sector investment will rise by 6.6 percent. Saunders said the Chancellor would need to lift planned level of public investment in 2017/18 by £3 billion-£4 billion ($4.8 billion-$6.5 billion) to match the projected growth in nominal GDP over that period.

That would be great news for business lobby groups clamoring for more infrastructure investment.

Osborne also defended another Conservative flagship policy to help stimulate the U.K.'s housing market. Help to Buy -- whereby people buying a property worth less than £600,000 can get a loan of up to 15 per cent of the price guaranteed by the government if they can afford a 5 per cent downpayment -- has drawn criticisms that it will start a housing bubble in the U.K.

(Read more: UK's Osborne will have to sacrifice some sacred cows)

The chancellor said that, with the Bank Of England acting as watchdog, the risk of a boom-and-bust market is reduced.

"I'm the first person to say we must be vigilant about avoiding the mistakes of the past.," he said.

"That's why I gave powers to the Bank of England to stop dangerous housing bubbles emerging.

"But too many people are still being denied the dream of owning their own home. So instead of starting the second phase of Help to Buy next year, we're starting it next week."

In the halls there was loud applause. But outside analyst and economists warned this was politics not good economics.

Osborne's speech ended in almost as hokey a fashion as it started. After prominent UK businesswoman Karen Brady praised Osborne for "being the right man.... Her man.... The man with the plan", the Chancellor ended his address to the conference with references about the sun starting to rise above the hill.

The parties, on Monday, went on a lot longer.

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