Britain’s ‘Weak’ Economy May Need Tax Cuts to Boost Demand, Institute Says

The U.K. economy will grow less than previously forecast this year and the government should cut taxes to boost the recovery, the National Institute for Economic and Social Research said.

Gross domestic product will rise 1.3 percent this year, compared with an April forecast of 1.4 percent, Niesr, whose clients include the U.K. Treasury and the Bank of England, said in a report in London today. Growth will accelerate to 2 percent in 2012.

“The U.K. economy is weak,” Jonathan Portes, director of Niesr, said at a press conference yesterday. “The sensible thing to do now, given where we are, would be a modest loosening of fiscal policy.”

The economy barely grew in the second quarter and manufacturing unexpectedly shrank in July, reports in the past week showed. Chancellor of the Exchequer George Osborne’s fiscal squeeze to reduce the record budget deficit is curbing growth, while consumers are being hit by inflation at 4.2 percent, almost twice the pace of wage growth.

Niesr said that weak growth and household spending mean the government will miss its target of balancing the nation’s books in 2015-2016 by around 1 percent of gross domestic product. Still, it added that there is “time to address this.”

“Further consolidation should not be introduced now,” the institute said. “In the short term, fiscal policy is too tight, and a modest loosening would improve prospects for output and employment with little or no negative effect on fiscal credibility.”

Gilt Demand

That credibility has prompted investors to buy U.K. debt. Foreign investors bought a net 16.9 billion pounds ($27.6 billion) of U.K. government bonds in the second quarter, up from 3.03 billion pounds in the previous three months, according to the Bank of England. The yield on the 10-year gilt fell to a record low of 2.76 percent yesterday.

Niesr also said jobs demand will “grind to a halt” next year and the unemployment rate will increase to 8.3 percent.

Simon Kirby, a research fellow at the institute, said that targeted tax cuts would help boost demand.

“The U.K. economy is being held back by domestic demand,” Kirby said. Additionally, with the crisis in the euro area, “the balance of risks is more heavily balanced on the downside compared to April’s forecast.”

BOE Meeting

As the recovery struggles to gather momentum, all 55 economists in a Bloomberg News survey forecast the Bank of England will leave its benchmark interest rate at a record low of 0.5 percent tomorrow. The central bank will also keep its emergency bond-purchase plan at 200 billion pounds ($329 billion), according to a separate survey.

The International Monetary Fund said on Aug. 1 that both the government and the Bank of England should stick to their current policy plans for now.

Still, the fund said there were risks to the outlook and that there may be a need for stimulus such as tax cuts or bond purchases if weak economic growth and high unemployment persist. It maintained a forecast for 2011 and 2012 economic growth of 1.5 percent and 2.3 percent.

-- Editors: Fergal O’Brien, Craig Stirling

To contact the reporter on this story: Svenja O’Donnell in London at sodonnell@bloomberg.net

To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net

Bloomberg reserves the right to edit or remove comments but is under no obligation to do so, or to explain individual moderation decisions.

Please enable JavaScript to view the comments powered by Disqus.