ANALYSIS: The British economy - where to turn from here?

By Anna Tomforde Jan 25, 2012, 14:39 GMT

London - Sixteen months after leading the way in Europe with a bold programme of deficit-busting austerity measures, the British government is haunted by the prospect of economic stagnation and a possible return to recession.

A string of recent economic data has provided ample evidence of faltering economic growth, coupled with a squeeze on consumer spending power and a rise of unemployment to levels not seen since the mid-1990s.

At the heart of the problem has been lacklustre growth, which is expected to remain below 1 per cent in 2012, for the second year running.

The Conservative-led government, which blames part of the malaise on the spiralling crisis in the eurozone, has admitted that implementing the planned savings will take much longer than planned, and cannot be completed by the end of the current parliament.

In the autumn of 2010, when he announced plans to eliminate the structural deficit by 2015, through rigorous cuts in welfare and public sector spending, George Osborne, the Chancellor of the Exchequer, adopted a strident tone.

The path proposed by the government would lead to a 'steady and sustained economic recovery with falling unemployment,' Osborne promised then, claiming that Britain was the first country in Europe to tackle its debt problem.

But with latest figures showing a contraction of economic growth of 0.2 per cent in the last quarter of 2011, and unemployment at 2.7 million, confidence that these goals can be achieved has waned.

'Now Britain has substantial economic problems, debt built up over the past 10 years, and we are dealing with those, but the truth is that dealing with those problems is made more difficult by the situation in the eurozone,' Osborne conceded Wednesday.

The figures came just a day after the International Monetary Fund (IMF) cut its growth forecast for the British economy this year from 1.6 per cent to 0.6 per cent.

The IMF has also repeatedly warned Britain that its 'risky strategy' of applying stringent austerity measures at a time of sluggish growth could push Britain back into recession.

Despite the threat of recession - defined by two quarters in a row of a decline in GDP - Osborne insisted that he would stick by the austerity measures.

'We have got the right plan, we have got to stick to it,' he insisted, amid accusations from the Labour Party opposition that the government's policy had failed, and that it was at a loss at what to do next.

However, the British government said it was heartened by the fact that the economies of its main European competitors, Germany and France, were set to grow by even less this year, according to the IMF figures.

David Kern, chief economist at the British Chambers of Commerce, said the IMF growth forecasts showed that Britain was 'heading in the right direction.'

'It can be done. We are better than Germany and France,' said Kern, commenting on the government's strategy.

However, according to Vicky Redwood, chief economist at Capital Economics, the latest quarterly figures confirm that the British economy 'is already contracting again.'

'Indeed, our bet is that Britain is now back in recession and that the economy will continue to contract for most of this year,' she said.

The gloomy prospects were not lightened by Mervyn King, the governor of the Bank of England, who said in a speech late Tuesday that the road to economic recovery would be 'arduous, long and uneven.'

However, with record low interest rates and inflation continuing to fall, there was scope for further stimulus measures, King indicated.

It is now widely expected that the central bank will pump a further 75 billion pounds (116 billion dollars) into the economy in early February, via the purchase of government bonds, in what is known as a programme of quantitative easing.

Any such intervention by the central bank would extend the programme to a total of well above 300 billion pounds since 2009.

'Two years after becoming noticed for announcing a long programme of budgetary prudence, Britain is now caught in the much less exciting grind of implementation and economic adjustment,' said the Financial Times this week.