Osborne's big mistake

by Ed Bowsher on 25 January 2011  |  18 comments
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The UK economy has gone into reverse. George Osborne's austerity budget was a big mistake.

The UK economy continues to shock. We learned today that the UK economy shrunk by 0.5% in the three months to December. That’s a shocking figure given that the economy grew by 0.7% during the previous three months.

If the economy continues to contract during the current quarter, we’ll be back in recession! (The official definition of a recession is when an economy contracts for two quarters running.)

Admittedly, the fall can partly be explained by the snow. But not completely. The Office of National Statistics says that even if the weather had been good, economic growth would still have been ‘flattish’. In other words, growth would have been around 0%. Economists had forecast a 0.5% rise for the quarter.

So what does this mean?

The Bank of England is now much more likely to print more money this year in another round of quantitative easing. Today’s news also means that a rise in the base rate is less likely. I said last week that I expected a rise in the base rate by May at the latest. Now I’m not so sure.

The Bank of England will be reluctant to push up interest rates if economic growth remains anaemic. On the other hand, if the Bank takes no action at all on inflation, we risk the nightmare scenario of stagflation – that’s where you get a recession and inflation at the same time. I don’t envy the Bank’s boffins and I’m really not sure what I’d do if I were in their shoes.

But there’s one thing I am sure about. George Osborne’s austerity programme is a big mistake. 2011 is going to be a year of tax rises and spending cuts and those measures are bound to slow the economy down. Yesterday, the Chancellor could argue that the economy was strong enough to withstand the pain of these cuts, but now that’s clearly not the case. A weak economy will generate less tax revenue for the government and make it harder for the government to cut the deficit.

The most effective way to reduce a deficit is to have strong economic growth. That’s what happened last summer when surprisingly high growth was followed by an unexpectedly large fall in the deficit. I fear the news will be much bleaker in summer 2011.