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25 July 2012

Why today’s GDP figures will give Osborne sleepless nights

The recession leaves the UK's AAA rating in even-greater danger.

By George Eaton

In his response to today’s terrible GDP figures (the economy shrunk by 0.7% in the second quarter), George Osborne wisely resisted blaming the eurozone, the weather or the Jubilee for the third successive quarter of contraction. Instead, he dwelt on the UK’s “deep-rooted economic problems”. Britain has many long-term problems – an economy too dependent on finance, a lack of long-term investment, and persistently high levels of youth unemployment – but the charge against Osborne is that he has made them worse, not better.

Today’s figures mean that the economy is now smaller than it was at the time of the election and 4.5% below its 2008 peak. Even before the double-dip (and don’t say we didn’t warn you), the UK, unlike the US, Germany, France, and Canada, still hadn’t recovered the lost output from the previous recession. Osborne will hope for an Olympics-led recovery in the third quarter as the lost production from the Jubilee bank holiday is made up. But recent history suggests he would be wise not to count on it.

The deepening of the recession will do little to alter the demands of Labour and Tory MPs but it will amplify them. The problem for Osborne is that the constraints of the coalition and his decision to rule out fiscal stimulus in advance mean that he can offer neither the supply-side revolution that the Tories crave nor the Keynesian boost that Labour seeks. As a result, he has invested much of his hope in greater monetary stimulus by the Bank of England. But with the UK caught in a classic liquidity trap – when consumers are so determined to save that greater availability of credit makes no difference to growth – he is profoundly wrong to do so.

At times of recession, when consumer spending is depressed and businesses are hoarding cash, the state must act as a spender of last resort and stimulate growth through temporary tax cuts and higher infrastructure spending. Yet it is precisely this option that Osborne has rejected at every turn, dismissing well-intentioned critics as “deficit deniers”. Today’s figures are his reward.

A further consequence of the recession is that it will be even harder, if not impossible, for Osborne to meet his golden rules on borrowing. The IMF, whose prediction of 0.2% growth this year now looks hopelessly optimistic, has already warned that he will miss his target for national debt to be falling as a percentage of GDP by 2015-16. Today’s figures leave him even further away from that goal.

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While Osborne’s arbitrary targets are of little economic importance they are of immense political significance. Should he abandon his debt rule, the UK could lose its AAA credit rating. Standard & Poor’s, for instance, has previously warned that our top rating is conditional on Osborne meeting his fiscal mandate. But why should we listen to the discredited agenices that rated Lehman Brothers and AIG as “safe investments” days before the crash? The answer is simple: we shouldn’t. But this doesn’t alter the fact that Osborne did. Having adopted the UK’s credit rating as his metric of success (he once boasted that we were “the only major western country which has had its credit rating improve”) he can hardly change tact now.

The UK’s AAA credit rating is one of the few emblems of “credibility” the Chancellor has left. Its loss would be a final and possibly terminal blow to his authority.