IMF backs George Osborne on cuts

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Chancellor George Osborne received a boost today after the International Monetary Fund (IMF) said now was not the time to ease up on his deficit-reducing plans.

The IMF said that there had been "unexpected" weaknesses in UK economy over the past few months but judged these setbacks were temporary.

The global financial organisation downgraded its GDP growth forecast for 2011 from 2% to 1.5%, but maintained its 2.5% estimate for the medium term.

Signs of stalling growth in the UK over recent months have fuelled demands for the Government to show it has a "Plan B" rather than pushing ahead with public spending cuts.

However, the IMF said the Government programme of spending cuts and tax rises to eliminate the UK's structural deficit "remained essential".

In a highly-anticipated statement, the IMF backed the Government's approach to tackling the deficit.

It said: "Aided by the implementation of a wide-ranging policy programme, the post-crisis repair of the UK economy is under way.

"However, the weakness in economic growth and rise in inflation over the last several months was unexpected.

"This raises the question whether it is time to adjust macro-economic policies. The answer is no as the deviations are largely temporary.

"Strong fiscal consolidation is under way and remains essential to achieve more sustainable budgetary position, thus reducing fiscal risks."

A soft housing market, fiscal consolidation and the process of repairing the UK banks will continue to weigh on growth, the IMF said.

But private investment and stronger net trade - when exports outweigh imports - should help buoy the overall economic recovery.

Inflation is likely to remain above 4% for the rest of 2011, the IMF said, but will return to the Government's 2% target at the end of 2012.

The organisation backed the Bank of England's current monetary policy - that is record-low interest rates of 0.5% and £200 billion of quantitative easing.

However, the IMF said if growth resumes as expected in the coming quarters, the case for lifting interest rates would increase - but warned the changes should be gradual.

Elsewhere, the IMF said UK banks' balance sheets were recovering but that vulnerabilities remained.

Speaking at the launch in the Treasury of the IMF's annual Article IV report on the UK economy, Mr Osborne said: "I welcome the IMF's continued support for our overall macro-economic policy mix, including our deficit reduction strategy.

"The opening sentence of their report states 'The post-crisis repair of the UK economy is under way'.

"Difficult decisions on tax and spending inevitably generate opposition and some argue that there is an easier way.

"The IMF expert team have spent two weeks here engaging with all shades of opinion, including those who have been calling on us to change course.

"The IMF have publicly asked themselves the question of whether it is time to adjust macro-economic policies - in other words is it time to change course. They have concluded definitively that the answer is no."

Today's report warned that there remain "significant risks to inflation, growth and unemployment" which may require an adjustment to fiscal policy.

In the case of higher-than-expected inflation, it might prove necessary for the Bank of England to increase inflation rates more swiftly than currently anticipated, said the IMF.

On the other hand, if growth remains weak and unemployment high for a "prolonged period", the Government should consider temporary tax cuts targeted at low-income households, job creation or investment, along with renewed quantitative easing by the Bank, the report said.

But acting managing director John Lipsky declined to be drawn on how bad the economic outlook would have to get before alternative plans should be introduced.

Like most major economies, UK had experienced slightly lower growth than expected in recent months, largely due to factors like the high price of oil, said Mr Lipsky.

He added: "Naturally, these deviations raise the question of whether it is time to adjust the macro-economic strategy. According to the IMF staff analysis, the answer is no. We expect the deviations from economic forecasts to be largely temporary.

"We expect the economic recovery to resume in 2011, albeit at a moderate pace. Although the unemployment rate remains unacceptably high, it appears to have stabilised and it is encouraging that employment growth has picked up recently."

Sources close to the Chancellor said that the IMF analysis amounted to an explicit rejection of Labour's argument that it was time to increase public sector spending to boost growth.

Even in their worst-case scenario, the IMF recommend targeted tax cuts rather than increased spending, said a Whitehall source.