UK's GDP growth forecast at only 1.2 per cent

According to the IoD, five economic influences combine together to weaken GDP growth prospects this year: falling household real income, a flat savings ratio, upward interest rate expectations, the fiscal squeeze and anaemic broad money supply growth.

However, the IoD does not think the Chancellor needs to resort to a Plan B (i.e. slowing the spending squeeze). Instead we support the development of a parallel plan to the Spending Review, which focuses on significant supply-side reforms to the UK economy.

The IoD believes that if the Chancellor was to slow the reduction in public spending, it would be more damaging to GDP growth than maintaining the current course, owing to the negative impact on financial markets and business confidence.

Commenting on the UK’s economic outlook and the implications for policy, Graeme Leach, IoD Chief Economist, said: “In 2011-12 we think there is more of a risk to the economy from a mistake in monetary than fiscal policy. Raising interest rates when the money supply is so weak could undermine recovery and risks a double-dip.

“It is concerning that all the attention at present is on the risk to the economy from a mistake in fiscal policy and the challenge to the Monetary Policy Committee’s credibility from the acceleration in inflation. This tends to lead to calls to slow the spending squeeze and speed-up interest rate rises – somewhat contradictory.

“We take the opposite approach. The spending squeeze should proceed as planned and the MPC should avoid raising interest rates. In fact, broad money supply statistics suggest there is a case for an extension in Quantitative Easing if anaemic monetary growth continues.”