U.K. Economy Faces Worst Performance Since 1990s, Niesr Says

By Brian Swint

July 25 (Bloomberg) -- The U.K. economy faces its worst performance since the 1990s recession in the years before the next election, which Prime Minister Gordon Brown must call by 2010, forecasts by the National Institute for Economic and Social Research showed.

Britain's gross domestic product will rise 1.5 percent this year, 1.4 percent in 2009 and 1.9 percent in 2010, said the London-based group, whose clients include the Treasury and the Bank of England. That would be the worst spell since the three years through 1992.

``GDP growth is expected to be relatively anemic over the next three years,'' Niesr economist Simon Kirby wrote in a report published today. ``We see a modest slowdown rather than any recession,'' he told reporters yesterday.

The economy's performance may weigh on the fortunes of Brown's ruling Labour Party, whose support in opinion polls is close to the lowest since World War II and must call a general election by 2010. Higher credit costs and the housing-market slump have choked economic growth as accelerating inflation prevents the central bank from cutting interest rates.

Data today will probably show that the U.K. economy grew at the slowest pace in three years in the second quarter. GDP increased 0.2 percent, according to the median of 33 economists' forecasts in a Bloomberg survey. The statistics office publishes the initial estimate at 9:30 a.m. in London.

Bank of England Deputy Governor Charles Bean said yesterday that there is a risk of a ``prolonged'' slowdown in the economy, while the bank must also guard against faster inflation.

1990s Situation

``In 1990, the economic and fiscal situation was undoubtedly a lot worse than it is now,'' Martin Weale, director of Niesr, told reporters. ``Precedent by no means implies that Labour is doomed to lose the next election.''

John Major, the prime minister in 1992, led the Conservative Party to a fourth consecutive term that year as Britain emerged from its last recession. Brown will try to repeat the feat for his party after he succeeded Tony Blair last year.

Record oil prices are both damping growth and fanning inflation, which will stay at around twice the central bank's 2 percent target through the first half of next year, Niesr said. The group predicted it won't return to the goal until 2011.

The central bank, which cut the benchmark rate three times since December to cushion the economic slowdown, has now started considering increases from the current 5 percent.

``The Bank of England needs to send a strong signal that it is still focused on its remit,'' Kirby said yesterday. ``A quarter-point rise would be a useful sign.''

Pay Demands

Prospects for slower growth may be preventing workers from bidding up their pay to compensate for faster inflation. Annual wage gains slowed to 3.2 percent in the second quarter, creating the biggest gap between pay gains and retail-price inflation in 20 years, Industrial Relations Services said today.

Falling house prices may also add to consumers' woes. Property values fell the most in 15 years last month, HBOS Plc said July 10.

Brown has few prospects to spend more to bolster growth. Government borrowing will increase to 45 billion pounds ($90 billion) a year through 2010, Niesr forecast, and will break Brown's decade-old borrowing rule that debt should stay below 40% of GDP. The budget deficit ballooned to the widest since records started in 1946 in the second quarter.

``Any revisions of the rules now that the economic outlook has turned, such as those currently debated in the U.K., are harmful to their credibility in ensuring compliance with budgetary targets,'' ratings agency Standard & Poor's wrote in a note yesterday.

Brown should change the rules so that they can be relaxed in a recession and so that there is a penalty if the rules are broken. If the government loses credibility, investors may demand higher interest rates, Niesr said.

To contact the reporter on this story: Brian Swint in London at bswint@bloomberg.net.