LONDON (Reuters) - Britain's government should spend more now to fund investment and steer its economy back to recovery, the International Monetary Fund said on Wednesday, a call unlikely to be heeded by Chancellor George Osborne.
Economic data earlier on Wednesday highlighted the challenge facing Osborne. Retail sales slumped last month while a measure of public borrowing jumped to a record high.
In a relief for the under-fire Conservative-led government, the IMF's annual report did not repeat an explicit call by the Fund in April for Britain to consider slowing the pace of spending cuts aimed at reducing its hefty budget deficit.
Prime Minister David Cameron is under intense pressure from his own MPs over his policies on Europe and gay marriage and has had to quell speculation that his coalition might not last until the next election.
But at a news conference at Britain's finance ministry to present the report, IMF deputy managing director David Lipton made clear that he still thought a change of tack was needed.
"What is important now is not to make a mistake today and presume that all will be well with the economy some years from now. I think it's important to get started on infrastructure projects that will support the economy," he said.
As well as more spending on roads, housing and schools, lower corporation tax and incentives for firms to issue shares would help, Lipton added.
As Osborne sat watching, Lipton stressed he was not calling on the government to abandon the deficit-reduction plan that was a centrepiece of its 2010 election campaign, and which it has clung to even as the euro zone crisis buffets Britain's economy.
But the government should consider pushing back some of its belt-tightening to later in the five years over which Osborne aims to balance the budget.
"In essence ... allow the adjustment to take place in a more back-loaded fashion and provide more support for the economy at the front end of the period," Lipton said.
The IMF expressed concern that a scheme to boost the housing sector might simply push up prices and called for a "clear strategy" on returning state-controlled Royal Bank of Scotland and Lloyds Banking Group to private ownership.
Since the financial crisis, Britain has endured one of its slowest economic recoveries, although the outlook has improved after a 0.3 percent expansion in the first quarter of this year.
"Such promising news is encouraging. The UK is, however, still a long way from a strong and sustainable recovery," the IMF said in a statement.
Wednesday's data showed the biggest fall in retail sales in a year, while the Bank of England warned that growth could still be derailed by any worsening of the euro zone debt crisis.
"It's too premature to call the UK as being out of the woods," said Rob Wood, economist at Berenberg Bank.
Minutes of the central bank's May rate-setting meeting showed the majority of policymakers opposed to buying more government bonds.
But the IMF said it should keep the option of further monetary stimulus on the table and consider committing to keep interest rates at their record low into the medium term. Mark Carney, who will take over as the Bank governor from the long-serving Mervyn King on July 1, has favoured a similar policy.
The IMF stressed the importance of increasing lending to businesses, and told the government to come up with a plan to sell its controlling stakes in RBS and Lloyds, offering capital guarantees if needed. Osborne said he agreed - one of his clearest statements of intent on getting the giant banks off the government's books.
"Having refocused their business, now is the time for a clear strategy on how to return RBS and Lloyds to the private sector in a way that protects value for the taxpayer," he said.
But disagreement with the IMF over the key area of fiscal policy looks certain to continue.
The government argues that it has brought forward some investment and offers guarantees to private lending that do not require it to borrow even more and increase the budget deficit, one of the largest in the European Union.
The IMF, however, said measures to boost long-term growth would strengthen its economic credibility - an apparent challenge to Osborne's insistence that spending more now would hurt Britain's credibility in the bond markets.
"Raising growth expectations will do more for reassuring debt sustainability, while also helping restore banks to good health. And although supply measures are often thought to have only long-run benefits, they could bring immediate reassurance to purchasers of UK debt."
Additional reporting by Olesya Dmitracova and Christina Fincher; Editing by Catherine Evans