UK economy set to slow sharply, OECD warns

The UK economy is heading for a worse slowdown than expected, the Organisation for Economic Co-operation and Development (OECD) warned yesterday, cutting its predictions for growth and attacking government policy.

The international body slashed its forecasts for UK growth from 2 to 1.8 per cent for this year and from 2.4 to 1.4 per cent in 2009, much lower than the current Treasury forecasts of 2 per cent and 2.5 per cent respectively.

The OECD also warned the Government was in danger of breaching its own fiscal rules and criticised ministers for running an "excessively loose" fiscal policy over the past decade.

The Government's sustainable investment rule states that "public sector net debt as a proportion of GDP will be held over the economic cycle at a stable and prudent level", currently set at 40 per cent. However, the OECD warned: "It is clear much tighter fiscal policy will be required in the future if the rule is still to be respected. While ongoing economic weakness in 2009 would argue against fiscal restraint, the Government's options have been limited by excessively loose fiscal policy in past years when economic growth was strong."

If growth does come in at the levels predicted by the OECD and bodies such as the Bank of England and the IMF, the effect would be to push up public borrowing by about £10bn, to more than £50bn, the highest in 15 years.

The OECD also recommended the Bank of England should hold off from further interest rate cuts to stimulate the economy as inflationary pressures persist. The Bank's Monetary Policy Committee is today widely expected to leave rates at 5 per cent, the highest in the G7.

Fears that the economy is edging towards recession were compounded yesterday by figures from the Chartered Institute of Purchasing and Supply (CIPS). Its latest survey of business sentiment in the service sector – comprising three-quarters of the economy – showed output last month unexpectedly contracted for the first time in five years and consumer confidence fell to the lowest level since at least 2004. Input costs were at their highest in a decade.

Most worryingly, there are more strains appearing in the labour market. Roy Ayliffe, director of professional practice at CIPS, warned: "Purchasing managers saw jobs in the services sector hit badly after six and a half years of uninterrupted growth. Employment levels in the sector contracted sharply in May as waning workloads led to a significant culling of jobs. Not surprisingly, the hotels and restaurants sector reported the strongest decline in staffing levels. Financial services companies remained the worst performing in terms of activity, reportedly the result of the credit crunch."

Better news emerged from the British Retail Consortium, however. Prices in the shops rose at a sharply increased rate of 1.8 per cent year-on-year in May, up from 1.2 per cent in April and 1.1 per cent in March. However, the BRC said its members had been restraining inflation in the shops.