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Traffic passes the painted shutters of closed shops in Shoreditch, in London (LUKE MACGREGOR/REUTERS)
Traffic passes the painted shutters of closed shops in Shoreditch, in London (LUKE MACGREGOR/REUTERS)

British economy nosedive a bad omen Add to ...

Britain's economy has taken a wrenching step backward just as the country heads into a period of severe cutbacks, a warning to its troubled European neighbours that trying to spark a recovery amid harsh austerity measures will be a daunting task.

The British economy contracted 0.5 per cent in the last quarter of 2010, statistics showed yesterday, marking the sharpest decline since the second quarter of 2009, and a marked reversal from a gain of 0.7 per cent in the third quarter. The plunged brought year-over-year growth down to 1.7 per cent from 2.9 per cent the previous quarter.

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The decline occurred before government spending cuts begin to bite in the next fiscal year, signalling potentially even worse times ahead for the economy and serving as a stark reminder for the fiscally damaged countries of the euro zone how difficult it will be to maintain any kind of growth during a period of pullback. And unlike the members of the euro zone, Britain has an independent monetary policy to help cushion any blows stemming from deep cuts in public spending.

Several of the weaker members of the euro zone have already embarked on punishing cutbacks, unlike Britain, which is just starting. But Britain is the first country among the Group of 7 to report a reading of gross domestic product for the fourth quarter, signalling the challenges faced by the stumbling members of the euro zone, the 17 nations that share the common currency.

The weak economic numbers, which sent the pound reeling and raised the spectre of another recession, also put more pressure on the Bank of England to maintain rock-bottom interest rates even in the face of rising inflation.

"One thing it [the fourth-quarter slowdown]does without any doubt is that it re-emphasizes the importance that the Bank of England keep monetary policy extremely supportive," said Jonathan Loynes, chief European economist with Capital Economics in London.

Britain's coalition government also has some flexibility within its own fiscal rules to slow the guillotine, should conditions deteriorate further, an option not open to Greece, Ireland or other European countries that are already taking bailouts or facing dramatically higher financing costs.

"At the moment, the [planned]cuts would enable the government to meet its fiscal mandate a year early," Mr. Loynes said. "So there would be scope for a little bit of slippage."

But if policy makers soften their determination to get Britain's public finances into better condition, they fear it may well endanger the country's triple-A credit rating and cause bond investors to demand higher premiums for holding British debt, as they do for much of the euro zone. "For now, the U.K. government will want to distinguish itself very strongly from those countries," Mr. Loynes said.

Dreadful December weather was responsible for the fourth-quarter plunge in gross domestic product, according to the Office for National Statistics, which warned that the preliminary number is subject to wider revision than usual.

But some economy watchers questioned whether the freak snow storms that brought much of Britain to a standstill for days on end could have been enough to derail an entire quarter.

"It's more than the weather," said Carl Weinberg, chief economist with High Frequency Economics in Valhalla, N.Y. Retail sales in December did fall 0.8 per cent, but sales for the whole quarter were up 0.2 per cent. "So you can't explain the drop in GDP as a dearth of retail spending the day before Christmas. The numbers just don't support it."

More troubling, analysts said, is that even without the adverse impact of the December freeze, the economy was essentially flat.

It calls into question optimistic government growth forecasts of 2 per cent this year, 2.5 per cent in 2012 and higher after that. It also arms critics of the speed of the austerity cuts with extra ammunition. The weakness will lead opponents to argue that "the government is taking too many risks with the recovery and must be prepared to rein in the pace of fiscal correction if there is further evidence of the economy losing momentum," said Howard Archer, chief British and European economist with IHS Global Insight in London.

Nevertheless, "at this stage, we see the government sticking to its fiscal policy, given the political capital it has invested in it and its belief that changing tack now would have unfavourable repercussions," Mr. Archer said.

Indeed, both Prime Minister David Cameron and Chancellor of the Exchequer George Osborne insisted one bad quarter is not going to derail their austerity plans. "We will not be blown off course by bad weather," Mr. Osborne declared.

"Deficit deniers or the vested interests who oppose cuts to any item of public spending will probably claim that the [government]spending review or the VAT increase are to blame for today's growth data," Mr. Osborne wrote in the Evening Standard. "But there's a big problem with that argument - the data refer to the last quarter of 2010 when neither had yet begun."

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