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Niesr Sees 50% Chance of U.K. Recession on Euro Crisis Threat

The U.K. economy will grow less than previously forecast this year and next and there is a 50 percent chance it will slip back into recession, the National Institute for Economic and Social Research said.

The economy faces “significant downside risks,” Niesr said in a report published in London today as it cut its forecast for 2012 by more than half. It sees growth of 0.9 percent this year and 0.8 percent next year, down from 1.3 percent and 2 percent respectively in August.

“Recent poor performance has been driven by weak domestic demand, rather than developments in the euro area, but going forward these too will reduce economic growth,” it said. “The baseline forecast assumes a successful resolution of the euro area crisis; there are therefore significant downside risks.”

European leaders are battling to prevent their debt-crisis plan from unravelling after Greek Prime Minister George Papandreou said he would hold a referendum on the package, raising concern there may be a disorderly default. Chancellor of the Exchequer George Osborne said Nov. 1 the turmoil sparked by the decision will make the U.K. recovery “more difficult.”

“The downward revisions that we’ve had could turn out to be much bigger if some of the events in Europe become more clear,” Dawn Holland, senior research fellow at NIESR, said at a press conference. There is a “high probability” of double-dip recession across Europe, and a run on Greek banks may be likely if Greece is asked to leave the euro area, she said.

Euro ‘Worry’

Niesr, whose clients include the U.K. Treasury and the Bank of England, said the economy won’t return to its pre-recession peak until the end of 2013, making it the slowest recovery since the end of World War I. It also sees inflation easing from an average 4.4 percent this year to 2.3 percent in 2012.

“Looking forward, the real worry for us is the euro zone,”said Jonathan Portes, director of Niesr. While the direct impact on the U.K. from Greece potentially leaving the euro would be small, it would be worse “if there was knock-on impact on Italy and Ireland, both of which are much more important to the U.K.,” he said.

Niesr cut its global growth forecasts by about half a percentage point to 4 percent this year and 2012. As the outlook worsened, the Bank of England restarted emergency bond purchases last month, a move Niesr said was “appropriate.” Still, this may not be enough and Osborne should ease his fiscal tightening, it said.

The new stimulus “will not address the fundamental drag on business investment -- uncertainty with regards to future aggregate demand,” Niesr said. “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.”

With assistance from Namitha Jagadeesh in London

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