LONDON (Reuters) - Britain will slip back into a modest recession early next year, the OECD said on Monday, slashing its 2012 growth forecast and urging the Bank of England to expand its asset purchase programme significantly to boost output.
As Chancellor George Osborne was preparing to announce help for small businesses and other measures in his Autumn Statement on Tuesday to try and revive economic growth, the Organisation for Economic Co-operation and Development said the government may have to relax its deep austerity drive if conditions deteriorate further.
The Paris-based agency said Britain's output would fall by 0.1 percent in the fourth quarter of 2011 and by 0.6 percent in the first three months of next year, before picking up during the rest of the year.
Economists define a recession as two consecutive quarters of contraction.
The OECD predicted Britain's economy would grow by 0.5 percent next year, down from the 1.8 percent it forecast in May. Its prediction is just half the 1 percent average for 2012 growth seen in a Reuters poll of 42 economists conducted earlier this month.
Public spending cuts, falling household consumption and weak exports have weakened the UK economy, and more support is urgently needed to help it through strong headwinds, the Organisation for Economic Co-operation and Development said.
Its warning came as a survey by the Confederation of British Industry showed retail sales fell this month at their fastest pace since March 2009 as households reined in spending in the face of high inflation, weak wage growth and an uncertain economic outlook.
The Bank's decision to keep interest rates at a record low of 0.5 percent since March 2009 and to pump 275 billion pounds into the economy through the purchase of UK government bonds has been helpful, but it should go further, the OECD said.
Growth will be even weaker than forecast unless the central bank expands the scheme to 400 billion pounds by early 2012, a far higher figure than most economists expect by that time. That would leave the Bank with almost 40 percent of the total stock of outstanding government bonds, the OECD said.
"More support is needed urgently as headwinds are strong," the OECD report said.
Bank policymaker Paul Fisher said in a newspaper interview on Sunday that more quantitative easing may be needed.
Economists said that the euro zone crisis will limit Britain's exports and weak demand at home will undermine output.
"It is hard to see where any growth next year will come from," said David Tinsley, UK economist at BNP Paribas.
Britain's independent fiscal watchdog is also expected to cut its forecasts on Tuesday, forcing Osborne to borrow more to balance the books.
The finance ministry noted that the OECD supported its deficit-cutting plans and said the government was "using all levers to protect the UK economy."
"The UK economy is not immune to the turbulence in the euro zone and its impact on British businesses," it said in a statement. "But the difficult decisions taken by the government have made the UK a relative safe haven in the sovereign debt storm and helped to keep interest rates at record low levels for businesses and households."
Britain is one year into a programme of tax rises and spending cuts to eliminate a budget deficit that peaked at 11 percent of GDP. The Conservative-led coalition government has rejected opposition calls to ease up on its cuts.
The OECD said Britain should stick to its fiscal plans because they have bolstered credibility and helped maintain low yields on government bonds.
However, if the economy deteriorates more than expected, the government should consider short-term fiscal measures to boost output, for example by softening planned public investment cuts.
"Credibility will demand that the medium-term fiscal targets be retained and achieved, implying greater tightening later on," the OECD report said.
If things turn out to be worse than feared, banks may need to be recapitalised, preferably with private money. However, governments must be prepared to step in, the OECD said.
The report forecast that the UK unemployment rate will rise to 9.1 percent by 2013. That will exacerbate social problems and lead to a rise in the number of homeless people, the OECD said.
Reporting by Peter Griffiths; Editing by Susan Fenton