UK economy to enter recession soon, says report

The UK economy could rebound in 2013 if the eurozone crisis is resolved, Niesr said

The UK economy will enter recession in the first half of the year as households continue to cut back, an influential think tank has warned.

The National Institute of Economic and Social Research (Niesr) said the government should temporarily ease its spending cuts to promote growth.

It expects the economy to shrink 0.1% in 2012, but to grow 2.3% in 2013 if the eurozone debt crisis is resolved.

Niesr said, however, that deficit cuts had bolstered market confidence.

The UK is already close to another recession - defined as two consecutive quarters of economic contraction - after official figures in January showed that the economy shrank by 0.2% in the final three months of 2011.

In its UK and World Economy Forecast Niesr said: "We forecast a return to technical recession in the first half of this year, as households continue to retrench, credit conditions remain tight, and businesses are reluctant to invest given uncertainty about both domestic and foreign demand."

Niesr said economic conditions will not improve in the short term, as both the private the public sectors are still focused on paying off debts. "Over the near term we do not expect economic conditions to improve," the report said.

The think tank predicted that inflation would fall sharply, with the consumer price index down to 2.2% this year and 1.4% in 2013.

But there were grim forecasts on unemployment, which Niesr expects will rise to about 9% this year, from 8.4% in the three months to November, and will remain above 7% in 2014.

"Unemployment at this elevated level for such a long period is likely to do permanent damage to the supply side of the economy, with large long-run economic costs," the report said.

Niesr suggests relaxing the government's austerity programme. "The UK economy currently suffers from deficient demand; the current stance of fiscal policy is contributing to this deficiency. A temporary easing of fiscal policy in the near term would boost the economy," the group said.

Little scope

More investment would not derail the chancellor's long term fiscal goals, Niesr said.

On Monday, the Institute of Fiscal Studies said the government could safely cut taxes temporarily, without worrying that the Bank of England would raise rates in response.

But the IFS that there was little scope for big or long-term tax cuts, which risked undermining investor confidence.

"The chancellor faces his third budget with the economy and public finances in considerably weaker shape than he had hoped a year ago," said Paul Johnson, director of the IFS.

Last month, Chancellor of the Exchequer George Osborne said he would continue with the coalition government's efforts to reduce the deficit, despite criticism that it is choking off recovery.

A Treasury spokesman said: "As Niesr have said, the government's commitment to deficit reduction has helped maintain market confidence.

"They expect the government to meet its fiscal mandate and for the UK economy to grow more strongly than the euro area this year and next."

Meanwhile, Niesr forecast global growth of 3.5% for 2012, led by China and India, and 4% in 2013. It forecast US economic growth of 2% this year.An independent Scotland could be more constrained on economic policy than at present, a study has suggested.

Scottish independence

The report also considered the monetary and fiscal policy choices facing Scotland if it leaves the union.

Niesr concluded that retaining sterling would be "sensible" for Scotland, but warned that currency union could restrict fiscal policy.

The Scottish government said the report "validates" its aim to retain sterling and insisted Scotland would be in a "healthier" financial position.

The report said that it is "doubtful" whether the Bank of England would extend lender-of-last-resort facilities to Scottish institutions, something First Minister Alex Salmond has argued for.

Niesr adds: "With a pro rata transfer of existing UK public debt, Scotland would enter independence heavily indebted with no insurance from fiscal risk sharing or fiscal transfer mechanism with the rest of the UK.

"Even with a favourable settlement on future oil revenues, its fiscal balances are likely to be volatile with large deficits in some years as a result of its dependence on oil revenues," the report said.