Page last updated at 16:59 GMT, Wednesday, 6 August 2008 17:59 UK

IMF downgrades UK economic growth

Car production line
The report said the UK economy was slowing sharply

The International Monetary Fund (IMF) has cut its forecast for UK economic growth over the next two years.

The IMF predicted the UK would grow by 1.4% in 2008 and 1.1% in 2009, down from the 1.8% for 2008 and 1.7% for 2009 that it predicted in July.

It said inflation at 3.8% was higher than expected, and inflation expectations were rising even as as economic activity was slowing.

That, it said, meant the Bank of England had little room to cut rates.

The IMF growth forecast for 2009 is substantially below the official forecast of the UK government, which is still expecting growth to pick up to around 2.5% next year, and even lower than the consensus projections by independent forecasters of 1.4% growth.

The slowdown will put more pressure on the government budget at a time when it is facing a record deficit.

Budget gap

The IMF said that the government was likely to breach its fiscal rules, with the budget deficit above 3.5% of GDP for both 2008 and 2009, while the 40% debt ceiling was likely to be breached from 2009.

The IMF report is a damning judgement on almost every aspect of Mr Brown's legacy as Chancellor
Shadow Chief Secretary to the Treasury Phil Hammond

And it warned that the government was in danger of losing credibility if it made a too-drastic revision of the fiscal rules, as it is rumoured to be considering in the pre-Budget report.

In particular, it warned against any change to the budget ceiling of 40%, and suggested the government give an assurance that it will bring debt back below that level in a short time period.

The IMF pointed out that it could take years of fiscal adjustment, with sharp spending cuts or tax rises of up to 1% of GDP a year up to 2013, to bring the budget back into equilibrium.

The IMF gives its broad backing to the recently announced government plan to reform the system of financial stability to prevent another Northern Rock from emerging.

But it warned that "clarity of Bank of England authority and ability to act" in the next credit crisis were essential if the reforms were to work effectively.

'Inflation moorings'

The IMF's annual check of the UK economy said that the housing market had weakened markedly, while export demand remained subdued.

It also said that second quarter growth was weak and that unemployment has edged up.

"Given the outlook for inflation and the stance of fiscal policy, directors saw little scope for monetary easing at present," it said.

The IMF predicted inflation would exceed the Bank's 2% target for an "extended period".

It also said that if the "inflation anchor looses its moorings" the management of immediate macroeconomic challenges "will become even more difficult".

That, it said, would mean the burden on monetary policy rising, impeding exports, rebalancing, and eventual recovery.

However it did note that wage price pressures remained subdued.

The Bank of England's monetary policy committee is expected to keep interest rates on hold at 5% on Thursday.

Shadow Chief Secretary to the Treasury Phil Hammond said:

"The IMF report is a damning judgement on almost every aspect of Mr Brown's legacy as Chancellor."

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