IMF downgrades UK and calls for Plan B

The International Monetary Fund delivered a blow to George Osborne yesterday by downgrading its UK growth forecast for 2013 and issuing a politically awkward call for the Chancellor to ease up on his austerity programme.

In its latest World Economic Outlook, the IMF slashed its forecast for Britain in the present year to 0.7 per cent, down from the 1 per cent it expected in January. It also cut its forecast for growth in 2014 from 1.8 per cent to 1.5 per cent. The combined downgrade was larger than for any other advanced economy.

Mr Osborne has placed great emphasis on the IMF's support for his fiscal consolidation plans since his first Budget in June 2010. But yesterday the multilateral Washington-based institution spelled out a reversal of this support, saying the UK recovery was weak and that "consideration should be given to greater near-term flexibility in the fiscal adjustment path".

Last May the IMF, in its annual review of the UK economy, said Mr Osborne should consider what amounts to a Plan B if growth deteriorated. There are now fears Britain could fall into a triple-dip recession and the IMF's intervention yesterday represents a hardening of its position. Its chief economist, Olivier Blanchard, warned in an interview with Sky News that the Chancellor could be "playing with fire" by cutting spending while the economy remained weak. The shadow Chancellor Ed Balls, who has long called for a Plan B, said that the IMF was "right to step up their warnings and insist that a change of economic policy is considered right now". Mr Balls added: "These downgraded growth forecasts are yet another damaging blow to a downgraded Chancellor whose economic policies have totally failed".

In addition to its suggestion of a change of fiscal course, the IMF said that the Bank of England should consider "other forms of monetary easing" in a reference to suggestions the Bank should buy assets other than gilts in its quantitative easing programme. This is something the Bank's outgoing Governor, Sir Mervyn King, has consistently opposed, although his successor, Mark Carney, is more amenable.

The IMF downgraded its 2013 global growth forecast from 3.5 per cent in January to 3.3 per cent, reflecting what it described as a "bumpy" recovery for advanced economies. The eurozone outlook is now expected to suffer a larger contraction this year, shrinking by 0.3 per cent rather than the 0.1 per cent expected in January. The IMF downgraded France and Italy by 0.4 per cent points respectively for 2013.

However Japan, which has launched a significant programme of monetary and fiscal stimulus since January, received a hefty upgrade from the IMF. The Asian economy is now seen as growing by 1.6 per cent in 2013 and 1.4 per cent in 2014, an upgrade of 0.4 per cent and 0.7 per cent respectively.

In response to the UK downgrade, the Treasury pointed out that the UK is still forecast by the IMF to grow by more than Germany in 2013 ( which is expected to expand by just 0.6 per cent). "We are slowly but surely fixing this country's economic problems" said a spokesperson.

Government sources indicated there will not be a change of fiscal course in response to the IMF advice.