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LONDON (Reuters) - A windfall payment of tax by Swiss banks caused Britain's public finances to post a smaller-than-expected deficit in May, and underlying figures suggested the government was on track to meet its budget target this year.
Deficit reduction is the central economic policy of Britain's Conservative-led coalition, which came to power in May 2010. At that point Britain's budget deficit was more than 11 percent of annual economic output - one of the highest rates for a major economy.
But public borrowing has remained stubbornly high over the past year, and data showed total public net debt climbed to record levels in May.
The budget deficit stood at 7.8 percent of gross domestic product on an underlying basis in the tax year that ended in March, down only a fraction from the previous year due to sluggish economic growth.
Friday's data from the Office for National Statistics showed that two months into the new tax year, the government is on track to meet this year's similarly modest deficit-cutting goal.
The government's preferred measure of Britain's public borrowing, which strips out some of the effects of its bank bailouts, showed a deficit of 8.8 billion pounds in May, almost half the shortfall in May 2012 and well below analyst forecasts of a deficit of 12.6 billion pounds in a Reuters poll.
Some of the fall had been expected because of a scheduled 3.9 billion-pound cash transfer from the Bank under a controversial deal last year to return interest payments on the BoE's massively increased gilt holdings to the government.
But most economists had not expected an upcoming payment of 3.2 billion pounds from a Swiss tax deal to be booked so soon.
Swiss banks agreed last year to settle the tax affairs of British citizens with undeclared bank accounts in the Alpine country, but the exact timing of the payments was not clear.
Analysts were confident the government would meet its 2013/14 goal of borrowing no more than 120 billion pounds, excluding the boost from Bank cash transfers.
"Overall the early signs for the new fiscal year are that the government can afford to be optimistic about meeting the full-year target for core borrowing excluding the QE cash flows," said Sam Hill, a fixed income strategist at RBC.
There was also good news for the government as the ONS revised down its previous estimates for borrowing in the last three tax years by more than 4 billion pounds although government debt is still far higher than forecast in 2010.
Britain's total net public debt, even excluding the direct costs of bailing out the country's banks, now stands at 1.189 trillion pounds - equivalent to 75.2 percent of GDP.
When Chancellor George Osborne gave his first budget after his Conservative-led coalition came to power in May 2010, he aimed to have reduced the deficit to 5.5 percent of GDP by now and for debt to peak at just over 70 percent of GDP this year before falling.
While the opposition Labour party blames this failure on an excessively rapid initial pace of deficit reduction that it says stopped the economy from growing, the finance ministry says it is largely due to the crisis in the euro area, Britain's main export market.
Next week Osborne is due to set out plans for public spending restraint until April 2016 - a year after the 2015 national election. While he set out the total amount of spending in his March budget, individual government departments have yet to find out how much they will receive.
Editing by Hugh Lawson