The British government unveiled sharply lower economic growth forecasts today and said it would take longer than hoped to wipe out its deficit, meaning that tough austerity measures would extend beyond 2015.
Chancellor George Osborne warned that the British economy risked getting dragged into recession if the euro zone debt crisis was not solved.
"If the rest of Europe heads into recession it may prove hard to avoid one here in the UK," he told parliament.
"Much of Europe appears to be heading into recession caused by a chronic lack of confidence in the ability of countries to deal with their debts. We will do whatever it takes to protect Britain from this debt storm while doing all we can to build the foundations of future growth," he said.
The economy was now forecast to grow by only 0.7 per cent next year, way below a March budget forecast of 2.5 per cent, Mr Osborne said, presenting figures from the independent Office for Budget Responsibility (OBR).
Growth was expected to recover to 2.1 per cent in 2013.
The prospect of years of fiscal austerity will fuel anger among unions on the eve of a one-day strike by 2 million public sector workers over government spending cuts that will make them pay more and work longer for their pensions.
Borrowing will fall much less than expected because of slower economic growth, erasing any room for error in the coalition government's deficit reduction plan.
Mr Osborne said the independent Office for Budget Responsibility forecasts showed borrowing would fall to £79 billion in 2014/15, against a March budget forecast of £46 billion. For next year, public sector net borrowing is now forecast to total £120 billion, up from the March prediction of £101 billion. The structural deficit would be erased by 2016/17, Mr Osborne said.
The new figures bring the government broadly into line with independent forecasters.
The OECD rich nations' economic think-tank said yesterday that Britain will slip back into a modest recession early next year. It lowered its 2012 growth forecast to just 0.5 per cent and urged the Bank of England to expand its money-printing programme.
Despite fears that the country is being pushed back into recession, the government will not fundamentally change tack with no additional borrowing or savings announced.
Britain has enjoyed record-low borrowing costs thanks to its perceived status as a safe-haven from the euro zone debt crisis, which helps alleviate the pressure on public finances.
The yield on 10-year gilts has been trading at 2.3 per cent, well below the 3.8 per cent average rate projected by the OBR in March, resulting in a total debt interest saving of £22 billion up to 2016, Mr Osborne said.
What stimulus there is, is likely to come from monetary policy.
The Bank of England will pump an additional £75 billion into the economy in coming months, a Reuters poll indicated today, taking the total to £350 billion as it tries to revitalise growth.
"The UK is partway through a 'lost decade', and I expect that 2012 will be another difficult year," said Michael Saunders at Citi, who expects the total BoE spend to be at least £500 billion - the highest forecast in the poll.
Recognising that he has little scope to alter Britain's short-term economic prospects, Mr Osborne focused on measures that will boost growth in the longer term, such as promoting lending to small businesses and encouraging private sector investment in infrastructure.
He plans to tap British pension funds to provide the bulk of up to £30 billion of investment in building projects, while the government will underwrite £20 billion of loans to smaller companies struggling for credit.
