Business

Published: Friday August 3, 2012 MYT 8:06:00 AM

Britain's economy to shrink in 2012


LONDON: Britain's economy will shrink this year and any meaningful recovery will remain elusive until 2014 as the euro zone debt crisis and the government's spending cuts weigh heavily on the country's prospects, a leading think-tank said on Friday.

The National Institute for Economic and Social Research (NIESR) said the country's output could have been 239 billion pounds higher in total between 2011 and 2021, had deficit reduction been postponed by three years.

NIESR's analysis together with its forecast of a decline in gross domestic product by 0.5 percent in 2012, followed by only 1.3 percent growth in 2013, will fuel the heated political debate about the speed of Britain's fiscal consolidation.

The coalition government of Conservatives and Liberal Democrats has so far rejected calls to ease its tough plan of spending cuts and tax hikes, but the pressure is mounting after news that the country is slipping deeper into recession.

The shock drop of output by 0.7 percent in the second quarter - when one-off effects such as an extra holiday to mark Queen Elizabeth's 60 years on the throne and extremely wet weather compounded the general weakness - was the main driver behind NIESR's lower GDP forecast for 2012.

The economy was probably still in recession when stripping out those effects, which are likely to lead to a rebound in the headline growth rate in the third quarter, NIESR economist Simon Kirby said.

But more importantly, the economy had not grown over the past two years and the debt crisis in the euro zone - destination for over 40 percent of British exports - would continue to hurt Britain, Kirby said.

The 1.3 percent growth for 2013 was masking an even weaker momentum as some of the growth was due to inventory build-ups.

AUSTERITY HIT

However, unemployment looked now set to peak at 8.6 percent next year, below NIESR's previous forecast of around 9 percent.

And despite weaker growth, the government was still likely to meet its goal to erase the structural budget deficit by 2017.

The think-tank applauded the government's recent steps to boost the economy such as the Funding for Lending Scheme to get credit flowing, but it also reiterated its long-standing call for direct spending to kick-start growth.

"It remains the case that there is scope for a less aggressive path of fiscal tightening," NIESR said.

"The government should consider on-balance sheet funding of key projects, concurrent with a comprehensive restructuring of banks and key funding markets," the economists said.

The think-tank also analysed how an alternative path for fiscal consolidation would have played out.

By postponing any tightening to the 2014/2015 fiscal year, the loss of output would have been smaller because a depressed economy was more vulnerable to the fiscal headwinds, NIESR said.

The government launched its austerity programme in late 2010 and the opposition Labour party has since criticised finance minister George Osborne for cutting too fast and too far.

The government's plan still enjoys support from bodies such as the Organisation for Economic Cooperation and Development (OECD) and the International Monetary Fund (IMF), though the IMF has warned that fiscal loosening may become necessary if the economy fails to gain traction over the next six months.

The onus to support the economy has been on the Bank of England, which on Thursday stuck to its plan to buy another 50 billion pounds of government bonds. Most BoE observers see more quantitative easing and even a cut in the base rate.

However, given the impaired banking system such a rate cut was unlikely to provide much of a boost, NIESR economist Kirby said, adding that more purchases of government bonds also showed diminishing returns. - Reuters

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