Economy to shrink in 2012, needs government boost - NIESR

LONDON (Reuters) - Britain's economy has entered a mild recession and will shrink in 2012, a leading think-tank said in a report on Friday, urging the government to boost near-term spending to prevent long-term damage from higher unemployment.

The National Institute of Economic and Social Research (NIESR) predicted a GDP drop of 0.1 percent this year as the unresolved euro crisis weighs on export prospects and business confidence.

The institute sees the unemployment rate rising to 9.1 percent, and warned that even the expected recovery from 2013 onwards might not bring joblessness back to its pre-crisis level, which would create higher structural unemployment.

Britain was running the risk of "significant long-term economic and social damage" without measures to boost job creation, NIESR's director Jonathan Portes said.

The government would have room to boost spending in infrastructure projects in the near-term without harming Britain's credibility as a debtor, Portes said.

The institute has long urged the government to ease its austerity drive. It estimated in the report that debt-financed investment spending of around 15 billion pounds would reduce the expected unemployment rate by 0.3 percentage points.

"The credible commitment to a sustainable fiscal policy over the longer term provides the government with the flexibility to provide a clearly defined and temporary boost to near-term demand," the institute said.

On Wednesday, fiscal policy think-tank IFS said the case for government stimulus had grown, though it noted the risk that spending financed through extra borrowing might erode market confidence and drive up borrowing costs.

The debate about the government's tough austerity plans, aimed at erasing the budget deficit over the next five years, has intensified again ahead of the budget announcement due on March 21 as the economy shrank at the end of 2011.

The government's fiscal watchdog OBR predicts growth of 0.7 percent for 2012. NIESR had forecast growth of 0.8 percent for 2012 in October, under the assumption that the euro zone crisis would be largely resolved by the end of 2011.

The economists at NIESR said the economy looked set to contract by another 0.2 percent in the first quarter and by 0.1 percent in the second before starting to recover. The institute predicts a return to healthy growth of 2.3 percent in 2013.

Inflation was set to fall below 2 percent in the second half of this year and stay below the Bank of England's target throughout 2013 and 2014, providing the central bank with leeway to add further stimulus at its meeting next week.

(Reporting by Sven Egenter)