Leading article: Economic contraction will have political consequences

Ed Balls, the shadow Chancellor, is on the verge of being able to claim vindication

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The snows have disappeared, but a chill nevertheless crept up the spines of Coalition ministers yesterday. The latest figures from the Office for National Statistics, indicating that Britain's GDP contracted by 0.5 per cent in the final quarter of 2010, have left fiscal hawks grasping for reasons for optimism.

George Osborne stressed the reasonably robust performance of the manufacturing sector, and the economic disruption caused by the snow late last year, insisting that "we will not be blown of course by bad weather". Yet, as the ONS pointed out, even without the disruption brought on by heavy snow last month, growth would have been flat. It seems that in 2010, the UK's first full year out of recession, the economy grew by 1.4 per cent. That is hardly the robust expansion required to restore the country back to economic health.

Some hawks have put the disappointing figures down to "construction effects". But though the construction surge of the third quarter of 2010 manifestly fell away, that was because government building projects came to an end. That merely demonstrates how reliant the recovery was on public spending last year. This reinforces the argument for maintaining government stimulus, not removing it.

Yesterday's figures could not be worse timed from the point of view of the Government's aggressive deficit reduction plan. The VAT hike earlier this month was expected to cause consumers to bring their spending forward. If it did so, the benefits for retailers were unspectacular. And now the rate rise promises to depress consumer demand further.

The cost of living is on the increase too. The Governor of the Bank of England warned in a speech in Newcastle last night that inflation could hit 5 per cent this year. Rising prices are prompting calls for interest rate rises, which would increase the cost of borrowing throughout the economy. And the bulk of the public spending cuts from Mr Osborne's emergency Budget have yet to be felt. Tens of thousands of public employees are expected to lose their jobs this year. Youth unemployment already stands at almost 1 million. A private sector this weak is most unlikely to create sufficient jobs to meet the imminent explosion in demand for employment. The outgoing head of the CBI, Richard Lambert, criticised the Government earlier this week for focusing on cutting the deficit while neglecting to offer a serious programme for growth. Those criticisms now look prescient.

There will be profound political implications unless growth is shown to have rebounded strongly in the first quarter of 2011. The credibility of the Chancellor is on the line. The Liberal Democrat leadership, who took a gamble that the economy would survive the Conservatives' fiscal medicine, is going to find itself under increasing pressure. As for Labour, the new shadow Chancellor, Ed Balls, is on the verge of being able to claim vindication for his warnings that the Coalition's programme would derail the recovery.

The Conservatives tried to go on the offensive against Mr Balls yesterday, pointing out that he disagreed with the plan drawn up by the former Labour Chancellor, Alistair Darling, to halve the deficit in four years. But with the return of the spectre of a double-dip recession, Labour's historic disagreements on the deficit shrink into irrelevance. A Conservative Chancellor has embarked on the most severe fiscal consolidations in 30 years, explicitly rejecting any thought of a "Plan B". That suddenly looks less like bravery and more like supreme recklessness.

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