Battered Britain hovers on the edge of double-dip recession - The Guardian

With pasties, pensioners and philanthropists still dominating the headlines a month after the budget, the chancellor's fumbled tax grab has rocked his reputation as a smooth political operator. But on Wednesday, the focus will switch back to George Osborne's handling of the economy, when official figures reveal whether the UK slipped back into recession in the first three months of the year.

Osborne boasts that his deficit-cutting spree has made the UK a "safe haven", helping to keep the government's borrowing costs down by retaining the confidence of financial markets.

But after the 0.3% decline in GDP in the final quarter of 2011, a negative number on Wednesday would mean a double-dip recession, and force the chancellor to explain how the coalition has dragged the economy from recovery back into the danger zone.

With mixed signals from different sectors of the economy, City analysts are divided about whether growth has picked up since the dark days of late 2011, when the prospect of a full-blown credit crunch in the eurozone sent business confidence through the floor. Business surveys have been relatively upbeat; but manufacturing output fell sharply in January and February, according to the Office for National Statistics, and construction too looks extremely weak.

Last week brought some modest reasons for optimism. Labour market data showed the first decline in unemployment for almost a year – though a record 1.4 million people are working part-time because they can't find a full-time job, a sign that firms remain cautious. Retail sales figures, released on Friday, were relatively strong, even without the artificial boost from panic-buying of petrol.

"I'm glass-half-full," says Alan Clarke of Scotia Capital, who is expecting the Office for National Statistics to announce GDP growth of 0.2%, although he adds: "I wouldn't rule it out being negative."

There is also growing evidence of a change of mood on the Bank of England's monetary policy committee. Minutes of its April meeting, released last Wednesday, showed members fretting more about above-target inflation than sickly economic growth. And after official inflation figures showed a surprise rise to 3.5% in March, Paul Tucker, the Bank's governor-in-waiting, admitted in a speech that inflation remains "uncomfortably above target", and there was "considerable uncertainty about the path that it will follow".

Adam Posen, the American economist who consistently warned about the weakness of the economy last year, and eventually won the argument for an extension of the Bank's emergency quantitative easing programme, voted against another increase in QE in April.

The City read his change of heart as a powerful signal that once the Bank has run through the last of the £325bn it has promised to spend, QE will be halted for the foreseeable future.

Inside the Treasury, though, next week's number is being watched with anxiety. Although 0.1% growth would feel little different to most of Britain's battered households from a 0.1% contraction, in an economy that has been flatlining for a year, a batch of headlines about the return of recession could knock fragile consumer confidence.

And even if growth has picked up smartly in the first three months of the year, it's hard to feel confident about the rest of 2012. Output in the second quarter is likely to be temporarily depressed as a result of the extra bank holiday in June to celebrate the Queen's diamond jubilee, echoing the downturn last year as the nation celebrated the royal wedding by taking the week off.

Much more worryingly, the eurozone crisis is still rumbling ominously on across the Channel. Unemployment in the struggling peripheral countries has reached almost unthinkable levels – youth unemployment in Greece and Spain has shot through 50%.

With the French elections looming next weekend, there are also growing signs that political support for the savage austerity measures enshrined in Europe's "fiscal compact" is starting to crumble across the EU.

A Treasury spokesman concedes that events in the eurozone present the biggest risk to the outlook. "Recent data shows that the British economy is holding up: retail sales are up 1.8% in March and unemployment is down by 35,000 in the three months to February. But as recent developments across Europe demonstrate, there is still a lot of economic uncertainty emanating from the eurozone, which is having a chilling effect on the UK economy and weighing down on confidence."

There are potentially chilling influences back home too. Rising inflation in March may be a sign that strengthening demand is allowing retailers to pass on rising costs to their customers. But if, instead, it simply shows the knock-on effect of high commodity prices and rising taxes, then it will eat into consumers' spending power and force them to tighten their belts yet further. Higher-than-expected inflation was one of the key reasons cited by the independent Office for Budget Responsibility in November for getting last year's growth forecasts badly wrong.

Michael Saunders of Citi believes that a couple of positive pieces of data should not disguise the underlying weakness of the economy. "I just think we shouldn't get too carried away," he says.

And after almost five years of financial and economic turmoil, the UK remains saddled with many of the imbalances that made it vulnerable to the sub-prime shock in the first place. Households have made little progress in paying off the mountain of debts they were left with as a legacy of the pre-credit-crunch boom, property prices still look overvalued, and the financial sector remains enormous relative to the rest of the economy.

Dario Perkins of consultancy Lombard Street Research argued in a briefing last week that those imbalances have not mattered too much over the last couple of years, as rock-bottom interest rates and a smaller-than-expected increase in unemployment have helped to prevent the forced sales and mass repossessions that could have a created a vicious downward spiral.

But he says they could still leave the economy dangerously exposed if the eurozone situation worsens. "This situation seems stable for now, but the UK's 'safe haven' status is far from guaranteed. The economy remains vulnerable to its large financial sector and our banks are heavily exposed to Europe ... If something goes wrong in Europe – and that is still the direction in which we are headed – then the UK's economic outlook might appear very different."