U.K. to Miss Deficit Target as Economy Shrinks 0.5%, Niesr Says

The British economy will shrink by 0.5 percent this year, forcing Chancellor of the Exchequer George Osborne to miss his budget-deficit target, said the National Institute of Economic and Social Research.

The economic deterioration has been “even more pronounced” than previously forecast as private-sector retrenchment is made worse by fiscal consolidation and a “dysfunctional” financial system, the London-based research group said a quarterly report published today. Osborne will borrow 12.5 billion pounds ($19.5 billion) more than planned in the year through March 2013, Niesr said.

“All these factors will be a major drag on economic performance,” Simon Kirby, an economist at the institute, said in an interview. “The major problem in the U.K. economy is a lack of demand and the government can do things to boost demand.”

Osborne says he will resist the “siren calls” to borrow more money to underpin the economy, saying investors would turn on the U.K. in an echo of the pressures experienced by euro-area countries such as Spain. Standard & Poor’s last week reaffirmed Britain’s top credit rating despite the economy contracting for a third straight quarter between April and June.

Niesr had previously forecast no change in output this year. The institute, which has called for Osborne to loosen the fiscal stance by up to 2 percent of gross domestic product to help create up to 200,000 jobs, said the economy will grow by 1.3 percent in 2013, below a previous 2 percent forecast.

Osborne’s 2010 austerity program, which was extended for two years to 2017 in November, envisaged that the economy would be growing by 2.8 percent this year. Instead, it is 0.9 percent smaller than in the third quarter of 2010, shortly after Prime Minister David Cameron’s Conservative-led coalition took office.

Tax Shortfall

A shortfall in tax revenue caused by the recession has led many economists to doubt that Osborne can meet his goal of cutting the deficit to 120 billion pounds this fiscal year.

Cameron’s assertion that Europe’s debt turmoil is largely to blame for the economic malaise has been called into question by some economists and the opposition Labour Party, which argues the government is trying to cut the deficit too quickly.

Kirby said a slump in consumer spending, reflected in lower imports, will hurt the economy this year, while weaker exports to the U.S. and the euro area will act as a drag in 2013.

Niesr published research carried out with the London School of Economics and Political Science that estimates output would be 239 billion pounds higher by 2021 if Osborne’s austerity plan had been delayed by three years.

“We would be seeing a small amount of growth rather contraction,” said Kirby.

Niesr said the government needs to do more to fix the financial system and, while it welcomed initiatives like the Funding for Lending program that began this week, a piecemeal approach would not be enough to return credit conditions to normal.

The Bank of England yesterday maintained its bond-buying program at 375 billion pounds as policy makers wait to assess the outlook for the latest stimulus and their new lending program.

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