Effect of spending squeeze may be worse than forecast

Public spending cuts could be having a bigger impact on the UK's stuttering economy than previously thought, the Government's fiscal watchdog said yesterday.

The admission came in the Office for Budget Responsibility's assessment of its forecasting performance during the past two years, a period in which its growth predictions have consistently disappointed. The UK managed growth of just 0.9 per cent from 2010 to mid-2012, a fraction of the 5.7 per cent the OBR had originally pencilled in.

The OBR said it was "clearly possible" that the Chancellor's belt-tightening "exerted more of a drag on growth than we assumed", although it added that high inflation and a weak trade performance were more likely culprits as household spending suffered last year and exports fell away thanks to the eurozone crisis.

It said: "Along with many other forecasters, we significantly overestimated economic growth over the past two years. This likely reflected several factors, including the impact of stubborn inflation on real consumer spending; deteriorating export markets on net trade; and impaired credit conditions, euro area anxiety and demand uncertainty on business investment. Fiscal consolidation may also have done more to slow growth than we assumed."

Its comments come after the IMF said the impact of fiscal tightening on growth may have been far more severe than it originally thought. The organisation said estimates of a "fiscal multiplier" of 0.5, meaning every £1 of cuts taking 50p out of the economy, could have been "significantly too low", meaning austerity is doing more damage than first thought.

The OBR's assessment is likely to fuel the debate about the Government's austerity drive as the UK has wallowed in a double-dip recession since last autumn, a slump the independent forecaster failed to spot.

The Office for Budget Responsibility also warned that the financial crisis may have caused a lasting hit to the economy's ability to grow.