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Austerity Double-Dip Watch: The United Kingdom

Jennifer Ryan:

Economy Shrinks More-Than-Expected as December Freeze Precedes Budget Cuts: Britain’s economy unexpectedly shrank the most in more than a year in the fourth quarter as construction slumped and the coldest December in a century hampered services and retailing. Gross domestic product fell 0.5 percent after increasing 0.7 percent in the previous quarter, the Office for National Statistics said in London today. Growth would have been “flattish” without the impact of the weather.... The pound dropped after the report, which shows the U.K. recovery faded even before Prime Minister David Cameron’s government increased sales tax to 20 percent this month, which may damp consumer demand this year. The data may reinforce calls for the Bank of England to hold off increasing its key interest rate to curb inflation. Governor Mervyn King, who leads the bank’s divided policy committee, delivers his first public speech of the year later today.

“The economy is underheating, not overheating,” Neil Mackinnon, an economist at VTB Capital Inc. in London and a former Treasury official, said in a phone interview. “An interest-rate increase would easily push the economy back into recession and would be a major policy error.”... The GDP drop is the biggest since the second quarter of 2009, when it fell 0.8 percent.... While these are “obviously disappointing numbers, there is “no question of changing” the fiscal plan, U.K. Chancellor of the Exchequer George Osborne said. “We will not be blown off course by bad weather.”

His opposition counterpart Ed Balls said in a statement that the figures were a “matter of great concern.” “George Osborne and the Treasury must urgently re-think their reckless plan to cut the deficit too far and too fast and start putting growth and jobs first,” Balls said....

King is due to deliver his speech in Newcastle, England at 7:40 p.m. local time. The Bank of England left its key rate on hold this month, and the outlook for growth and inflation has divided U.K. policy makers. Consumer-price increases accelerated to an annual 3.7 percent in December, the 13th month it’s been above the central bank’s 2 percent target. While policy maker Adam Posen has described recent price gains as temporary, his colleague Andrew Sentance said late yesterday it’s a “mistake” to label “global factors affecting inflation as one-off short-term disturbances.” “Emerging market and developing economies which appear to have shaped global price developments over the past decade, and this pattern looks set to continue into the future,” he said....

“Any notion that interest rates were going to be put up earlier than the fourth quarter this year, this is the final nail in the coffin for that sort of talk,” said Hetal Mehta, an economist at Daiwa Capital Markets Europe Ltd. in London. “The government will have to rely on the Bank of England to keep interest rates very low for a very long time in order to allow them to continue with their fiscal tightening.”

Snow last month kept Britons away from shops, creating the biggest-ever drop in retail sales for a December. Surveys by the Chartered Institute of Purchasing and Supply and Markit Economics Inc. showed services and construction also shrank....

The recovery faces further headwinds from government cuts to tackle a deficit that widened to 15.3 billion pounds ($24.4 billion) in December from 14.3 billion pounds a year earlier. The shortfall is projected to hit 10 percent of GDP this year.