Gloomy forecast for UK's economy

Updated: 
George OsborneBritain's GDP will shrink by 0.5% in 2012, a leading economic thinktank forecast today in one of the gloomiest assessments yet of the state of the economy.

The prediction by the National Institute of Economic and Social Research (Niesr) was down sharply from its zero growth forecast in May, issued before the publication of official figures showing the economy contracted by 0.7% in the second quarter of 2012 alone.

Niesr also downgraded its forecast for UK growth in 2013 from 2% to 1.3% and said that the "Jubilee effect" reduced growth this spring by 0.4%.

The deterioration in the UK's economy this year has been "more pronounced than even we expected", said the thinktank, which also said Chancellor George Osborne has "scope for a less aggressive path of fiscal tightening" and should consider stepping up investment in key projects to boost growth.

The report also found that the Government's decision to implement austerity immediately after it came to power may have cost the country a total of 16.5% in GDP growth over a decade - the equivalent of £239 billion in 2010 prices.

If the Chancellor had waited to introduce his deficit-reduction package of cuts and tax rises until 2014, by which time the recovery that began in 2010 would have been "well under way", he could have avoided this year's double-dip recession, said Niesr's experts.

Delaying austerity until 2014 would have ensured that unemployment kept below 7% throughout the decade, said the report. Instead, the jobless total currently stands at 8.1% and is forecast by Niesr to peak at 8.6% in 2013 and remain above 7% until 2016.

"The scenarios suggest that the recession in 2012 could have been avoided had fiscal tightening measures been delayed," said the report.

"Our estimates indicate that the cumulative loss of output from early consolidation accumulated over the period 2011-21 amounts to £239 billion in constant 2010 prices. This is equivalent to 16.5% of 2010 GDP or about 1.3% of total output over the entire period."

Although GDP can be expected to reach the same level by 2025 under either scenario, the Government's decision to take swift action has created "a substantial permanent deadweight loss... as the amplified losses in the early years will not be fully offset by amplified gains once recovery sets in", said the report.

"The concern today is that the Great Recession starting in 2008 and the consequent early fiscal tightening policies may lead to significant losses in output and a protracted period of high unemployment," said Niesr.

"The analysis presented in this note indicates that these concerns are well-founded.

"Under current policy plans the unemployment rate is expected to remain above 7% until 2016. Had tightening measures been delayed until economic recovery was well under way, cumulation output on the period 2011-21 would have been significantly higher, and the unemployment rate would have been expected to rise no higher than 7% over the next decade."

Niesr said that UK output had "effectively been flat" over the past two years, largely as a result of domestic economic factors, with the effects of the private sector paying down debts "exacerbated" by the Government's fiscal consolidation programme and a "dysfunctional" financial system.

The report forecast world growth slowing to 3.3% this year and 3.7% in 2013, with unemployment in some countries rising to levels higher than those of the Great Depression of the 1930s.

Niesr predicted that "tensions will heighten further" in the eurozone, as Germany enjoys above-trend growth, while southern Europe remains "in deep recession".

While the report predicted that the euro will survive, it forecast that Italy and Spain will need support and warned "the prevarication of the past four years can no longer continue".

"We expect the current remarkably low levels of official interest rates to continue well into next year," said the report. "Central bankers are often fond of saying they have plenty of other weapons in their armoury should it be necessary. If this is the case, the current time would seem to be appropriate to use them."

Niesr also warned that the USA is likely to fall back into recession unless the current stand-off between the White House and Congress over budget cuts is resolved.

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