Christine Lagarde: Time is running out for George Osborne's Plan A

Chancellor is urged to act to restore UK growth

Lagarde: 'Economic recovery in the UK has not yet taken hold' (PA)

George Osborne must adopt an economic "Plan B" and slow the pace of public spending cuts if the British economy remains weak, the International Monetary Fund warned the Chancellor yesterday. The managing director of the IMF, Christine Lagarde, came to the Treasury to deliver the sobering news: that the Government should consider slowing spending cuts if recovery stalls.

She also called on the Bank of England to do more to support the economy – presently in the grip of a double-dip recession – by printing more money.

The IMF repeated its broad backing for the Coalition's deficit reduction strategy. And unveiling its annual verdict on the British economy, Ms Lagarde said that Mr Osborne's 2010 Budget had successfully steered Britain away from a potential financial crisis two years ago. "When I look back to 2010 and what could have happened without fiscal consolidation, I shiver," she said. Nevertheless, the message that deficit reduction may need to be slowed down is awkward for the Government given Mr Osborne's repeated assertions to the contrary. The Labour Party has accused the Chancellor of undermining the British economy by cutting the deficit needlessly quickly. "Unfortunately the economic recovery in the UK has not yet taken hold and uncertainties abound," said Ms Lagarde. "The stresses in the euro area affect the UK through many channels. Growth is too slow and unemployment – including youth unemployment – is too high. Policies to bolster demand before low growth becomes entrenched are needed."

The IMF suggested temporary tax cuts, such as a reduction in VAT, and greater infrastructure spending, to help restore growth. "I think the sort of measures we have in mind are, one could consider cutting the value added tax," said the leader of the IMF's survey team, Ajai Chopra. "One could consider the payroll contributions because these can be credibly temporary."

The IMF stressed the initial response to the weak UK economy should come from the Bank of England, and urged it to extend quantitative easing" (money printing) and consider cutting rates below their record 0.5 per cent lows.

Ms Lagarde yesterday refused to specify when it would become necessary to implement a Plan B on deficit reduction, but the shadow Chancellor, Ed Balls, argued that the IMF's conditions for fiscal easing had already been met. "How much worse do things have to get before David Cameron and George Osborne finally take action?" he asked. "There is no case for delay and there can be no more excuses."

This is not the first time the IMF has recommended slowing the pace of deficit reduction if growth disappoints. Last August the IMF said the UK should consider tax cuts to stimulate the economy "if the economy appears likely to experience prolonged weak growth". And in October it advised Britain to delay some of its planned spending cuts and tax rises if activity were to "undershoot current expectations".

Since then the UK has fallen back into recession, with the Office for National Statistics estimating last month that GDP contracted by 0.2 per cent in the first three months of 2012, after falling by 0.3 per cent in the final quarter of 2011. The Bank of England has said it expects the economy to contract further in the second quarter of this year. The Paris-based OECD yesterday cut its 2012 growth forecasts for the UK economy from 0.7 per cent to 0.5 per cent.

The IMF report pointed out that the Chancellor had already, in effect, slowed the pace of his fiscal consolidation in the face of weaker than expected growth, noting that the scale of the cuts in this financial year will fall to 0.5 per cent of GDP, below the average tightening of 2 per cent in 2010-11 and 2011-12.

Ms Lagarde told ITV news: "As growth slowed and as the situation became more complicated, the deficit cutting has been slowed as a result of the system itself being more flexible. We regard that in the current economic situation as appropriate."

Despite its suggestion that a Plan B on deficit reduction might be necessary, Mr Osborne welcomed the IMF's findings: "The IMF couldn't be clearer today. Britain has to deal with its debts and the Government's fiscal policy is the appropriate one and an essential part of our road to recovery."

Policies for growth: IMF recommendations

* The Bank of England should cut its interest rate even further than the current all-time historic low of 0.5 per cent to cut the cost of borrowing.

* State investment in infrastructure (roads, public buildings etc) should be increased to boost employment.

* There should be a further squeeze on public sector pay.

* VAT or national insurance contributions should be cut to encourage spending and improve household finances.

* A new round of quantitative easing (printing money) should be considered to pump more liquidity into the financial system and free up more cash for banks to lend.

She said, he said: Osborne's spin on IMF report

"Unfortunately the economic recovery in the UK has not yet taken hold and uncertainties abound. The stresses in the euro area affect the UK through many channels. Growth is too slow and unemployment... is too high. Policies to bolster demand before low growth becomes entrenched are needed."

Christine Lagarde

"The IMF couldn't be clearer today. Britain has to deal with its debts and the Government's fiscal policy is the appropriate one and an essential part of our road to recovery. I welcome the IMF's continuing support for the UK deficit reduction plan."

George Osborne

News in numbers: The day's headline figures

3%: Inflation Good news. Sharply down from 3.5 per cent in March. If it keeps falling people should see their disposable incomes less squeezed. This should make them more inclined to spend, boosting the economy.

£325bn: Quantitative easing The Bank of England has bought up government bonds since 2009 to boost the economy. It stopped last month saying that the outlook was looking better. But the IMF wants a restart.

0.5%: Interest rates The Bank of England's policy has been to keep them at the record low since 2009. But the IMF suggested taking them even lower. The US central bank's rate is 0 to 0.25 per cent.

-4%: UK output below pre-crisis peak Performance shrank by 7 per cent in the 2008-09 slump. Since then output has recovered by less than half. Even optimists think the lost ground will not be recovered until 2014.

-0.1%: Contraction in eurozone GDP The OECD offers a gloomy forecast of what will happen to the output of the 17 nations of the eurozone this year. Its last forecast expected growth of 0.2 per cent in 2012.

11.1%: Eurozone unemployment by end of 2013 The OECD's forecast of the jobless rate across single-currency countries, up from 10 per cent now. It is already much higher in Spain (24.1 per cent) and Greece (21.7 per cent).

-1.5%: GDP contraction in Spain and Italy The OECD forecast for two of the eurozone's most vulnerable countries. Spain's debt is 70 per cent of GDP, Italy's 120 per cent. When their economies shrink, this ratio rises.

-5.3%: Contraction in Greece this year The OECD expects a fifth straight year of economic contraction and no return to growth until the second half of next year. Output has fallen 15 per cent since the start of the financial crisis.

-3.2%: Contraction in Portugal this year The OECD's growth projection came as the EC, IMF and European Central ECB arrived to check on Lisbon's slow progress towards meeting the conditions of its €78bn bailout.