Chancellor George Osborne will miss a key debt target unless he delivers new measures in his forthcoming mini-budget, the European Commission (EC) has warned.
The Government is unlikely to be able to reduce debt as a share of gross domestic product (GDP) by 2015/16 in light of recent public finance figures, the EC said. Mr Osborne will be forced to take action - such as further spending cuts or tax rises - in his autumn statement in December if the target is going to remain a possibility.
However, it is now widely expected that the Chancellor will admit the goal can no longer be achieved, rather than make the unpopular decision of unleashing further austerity measures on the UK.
The EC added that the "hard to explain" resilience of Britain's labour market is unlikely to remain so buoyant in the coming months with the unemployment rate expected to peak at around 8% in 2013.
The bleak assessment came as the EC slashed its growth forecast for 2012 from growth of 0.5% to a 0.3% decline as low consumer spending and eurozone turmoil take their toll.
The EC said the outlook for the remainder of 2012 "remains bleak", while 2013 should see a "marginal" improvement to growth of 0.9%, as rising wages and low and more stable inflation lift spending. The economy should continue to strengthen in 2014 with growth expected at 2%.
The EC said uncertainty in the economic outlook in the UK was holding back investment decisions with credit constraints, mainly for small businesses, dampening activity. While the flow of credit remained tight, measures such as the Funding for Lending Scheme (FLS), are expected to ease credit conditions in the private sector.
Elsewhere, the report said the outlook for the wider European Union remains fragile, but a gradual return to growth is projected for 2013. Employment in the region is expected to remain high.
The EC said GDP is set to contract by 0.3% in the EU and 0.4% in the eurozone in 2012, while it should grow at 0.4% in the EU and 0.1% in the euro area the following year.
Olli Rehn, EC vice-president for economic and monetary affairs and the euro, said: "Major policy decisions have laid the foundations for strengthening confidence. Market stress has been reduced, but there is no room for complacency. Europe must continue to combine sound fiscal policies with structural reforms to create the conditions for sustainable growth to bring unemployment down from the current unacceptably high levels."