UK economy forecast to shrink again

The UK economy will shrink 0.1% in 2012, the National Institute of Economic and Social Research (Niesr) said, as cash-strapped households tighten their purse-strings and nervous businesses hold back on investment.

Chancellor George Osborne's austerity measures are contributing to low demand in the UK, which in turn is damaging the broader economy, Niesr said, so a temporary softening of his fiscal stance would give the country a much-needed boost.

In addition, Niesr said an increase in Government investment would not derail the Chancellor's long term goals or prevent him hitting his fiscal targets.

Elsewhere, Niesr said the UK economy would rebound in 2013 with 2.3% growth - but only if a successful resolution to the ongoing eurozone debt crisis is found.

Meanwhile, the group forecast global growth of 3.5% for 2012, led by Asian powerhouses China and India, while the US should see 2% growth.

The UK is already close to another recession - that is two consecutive quarters of economic decline - after official figures revealed the economy shrank by 0.2% in the final three months of 2011.

In its UK and World Economy Forecast, Niesr said: "We forecast a return to technical recession in the first half of this year, as households continue to retrench, credit conditions remain tight, and businesses are reluctant to invest given uncertainty about both domestic and foreign demand."

The forecaster said economic conditions will not improve in the short term, with flat output this year, as both the private and public sectors clear off debts.

Unemployment will rise to about 9% this year, from 8.4% in the three months to November and will remain above 7% in 2014.

A jobless figure at this elevated level for a long period is likely to do "permanent damage" to the supply side of the economy, with large long-run economic costs, Niesr warned.

The thinktank added: "The UK economy currently suffers from deficient demand; the current stance of fiscal policy is contributing to this deficiency. A temporary easing of fiscal policy in the near term would boost the economy."

The eurozone is also expected to enter a recession as the debt crisis continues, lending conditions remain tight and unemployment is high.

The Chancellor last month pledged to stick to the coalition Government's austerity programme, which has been attacked for choking off the recovery, after the fourth quarter GDP figures were published.

He said: "Britain has substantial debts. If we don't deal with those debts, our problems will be worse."