In a report published just a week before Chancellor George Osborne presents his budget to parliament, the Organization for Economic Co-operation and Development also praised the government’s “ambitious” austerity measures.
However, it said the impact on spending and household income meant the recovery would be slow.
It revised down its forecast for economic growth this year to 1.5 percent from a projection of 1.7 percent in November, and it urged the Bank of England to keep monetary policy loose, despite a near-term rise in inflation.
The OECD’s 2011 growth forecast compares with an Office for Budget Responsibility estimate of 2.1 percent.
“The planned fiscal consolidation is needed to ensure that the fiscal position will be sustainable over time,” the OECD said in its first full survey of the UK since 2009.
“Nonetheless, it adds to the headwinds from weak real income growth, and a fading rebound in global trade.”
Britain is struggling to recover from its deepest downturn since World War Two, and harsh winter weather was only part of the reason behind an unexpected contraction in the last three months of 2010.
This has raised concerns about the strength of the recovery as the decline came even before the government implements measures to cut a record budget deficit of more than 10 percent of gross domestic product.
Nonetheless, the OECD gave a ringing endorsement of the coalition government’s ambitious plans to virtually eliminate the deficit over the next four years.
“While fiscal risks remain, the announcement and initial implementation of the consolidation program strikes the right balance between addressing fiscal sustainability and thereby reducing tail-risks on the one hand, and preserving short-term growth on the other,” it said.
But it said there was still room to make Britain’s taxation system more efficient, for example by abolishing exemptions from value added tax and raising lower rates of VAT. It also suggested raising the state pension age and simplifying the welfare benefits system.
In addition it urged the government to implement a permanent fiscal framework to guide policy beyond the current 5-year horizon, to discourage any let-up in consolidation.
“A future permanent medium-term framework might best ensure constraints on a shorter horizon than five years, as already suggested by the government.”
The OECD upped its forecast for inflation this year to 3.3 percent from 2.6 percent in November, but said the large degree of slack in the economy, modest underlying inflation and the dampening effect of fiscal tightening warranted loose policy.
“Policy rates should rise only slowly from mid-2011 onwards as long as inflation expectations do not drift too far from the target,” it said.
“The BoE will, however, need to react sooner, if inflation expectations begin to rise considerably or feed through to significant wage increases.”
