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5:46pm UK, Tuesday May 22, 2012
Britain may have to cut interest rates and VAT to stimulate the economy amid the eurozone crisis, the International Monetary Fund has warned.
But the IMF backed the UK’s deficit reduction plan, saying “substantial progress” had been made on balancing the books.
The head of the fund, Christine Lagarde, warned the eurozone crisis could prolong the UK’s recession and urged the Bank of England to take action to boost growth and reduce unemployment.
She advocated a cut in the base rate of interest, which has remained unchanged at a historic low of 0.5% for over three years.
In a report on the UK, the IMF warned an escalation of the crisis would deliver a “substantial contractionary shock” to the UK economy, setting back progress made towards recovery.
It said the Government should start preparing a Plan B, featuring temporary tax cuts and increased spending on infrastructure, to support the UK economy.
Britain entered a double-dip recession during the first quarter of the year after the economy contracted by 0.2%, following a decline in Gross Domestic Product (GDP) of 0.3% in the final three months of 2011.
The IMF identified uncertainty over the future of the euro as the main danger to recovery and warned: “Risks are large and tilted clearly to the downside.”
George Osborne has had his fiscal plans endorsed by the IMF
The report recognised “substantial progress” towards balancing Britain’s books thanks to the coalition Government’s deficit-reduction programme, but noted the economy remains “flat” and warned the weak recovery may be “more protracted than previously anticipated”.
IMF managing director Ms Lagarde put pressure on the Bank of England for further monetary stimulus to revive the economy.
She said: “Growth is too slow and unemployment, including youth unemployment, is too high.
“Policies to bolster demand before low growth becomes entrenched are needed.”
In an endorsement to Chancellor George Osborne’s economic strategy, Ms Lagarde added: “The UK authorities’ policy approach has reinforced credibility at a time of intensified global uncertainty.”
Referring to the UK’s budget deficit, Ms Lagarde said she “shivered’ when she thought about what would have happened if it had remained at the 11% of GDP level it reached in May 2010.
As debt-laden Greece teeters on the edge of being forced to leave the euro – leading to a potential catastrophe across the single currency bloc – the Chancellor said the UK was preparing for all eventualities.
“The British government is doing contingency planning for all potential outcomes.
“It’s our responsibility to ensure that while we work for the best, we prepare for something worse,” said Mr Osborne, who was speaking at a joint press conference with Ms Lagarde.
He added: “It’s clear we’re now reaching a critical point for the eurozone.
“Eurozone countries need to stand behind their currency or face up to the prospect of a Greek exit with all the risks that that would involve.”
The Chancellor also admitted ministers needed to do more to tackle unemployment, which currently stands at 8.2% despite modest falls over the last two months.
Serbia’s Tomislav Nikolic has watched how the recent Euro crisis has laid bare, not just the limits of pan European co-operation, but how, when times are hard, the very idea of it is quickly challenged.
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Shadow Chancellor Ed Balls, who would like to see a less radical approach to cutting the deficit, told Sky News that Mr Osborne’s plan had “failed”.
“The IMF is saying the UK economy is under-performing and needs urgent action to get jobs and growth moving,” he said.
The IMF warning came as UK inflation fell to its lowest level in more than two years, providing welcome relief to household budgets.
Meanwhile, the Organisation for Economic Co-operation and Development revised downwards its outlook for the eurozone.
It said it expects the euro area’s economy to contract by 0.1% this year, compared to a previous forecast of 0.2% growth, before returning to positive output in 2013.
The OECD warned the eurozone is facing a “severe recession” which poses a threat to economies across the world.
“The crisis in the euro area has become more serious recently, and it remains the most important source of risk to the global economy,” said OECD chief economist Pier Carlo Padoan.
The group left its outlook for 2012 for the UK economy unchanged at growth of 0.2%.