Chancellor George Osborne should be ready to slow the pace of his tough austerity measures and shake up the annual budget if the economy fails to come to life, the International Monetary Fund (IMF) has warned.
The IMF, led by former French finance minister Christine Lagarde, said the Government should ease its fiscal consolidation, which includes spending cuts and tax reforms, if the recovery continues to stall.
The organisation said Mr Osborne should consider introducing increased infrastructure spending in his next budget to boost growth, which could be funded by further tax reforms.
And in a further blow, the IMF said the Government was now expected to hit its goal of slashing the ratio of debt to gross domestic product a year later than hoped. The organisation significantly lowered its UK growth forecast for 2012 to 0.2% from 0.8% just three months ago, reflecting the UK's slide into double-dip recession.
The IMF judgment will come as a blow to the Chancellor, who has vowed to press ahead with his plans to lower the country's budget deficit over the next five years despite weak growth.
Shadow chancellor Ed Balls said: "This is a very serious warning to the Chancellor that urgent action to boost jobs and growth is needed."
The IMF tackled the controversial topic of Libor - the interbank lending rate at the heart of a fixing scandal that has rocked the banking industry, in particular Barclays. The organisation said it was "appropriate" that reforms to ensure the integrity of interest rates are considered. The findings of the investigation into Barclays by UK and US regulators, which ultimately fined the bank £290 million for rigging the Libor, were "disturbing and may have spillovers", the IMF said.
The IMF said it welcomed recent moves by the Bank to boost quantitative easing, after it ramped up its asset purchases by a further £50 billion. The organisation also backed the new £80 billion funding for lending scheme, unveiled last Friday by both the Bank and Treasury, which is designed to unclog the flow of lending to businesses and households.
But the IMF added that a number of its directors "considered that fiscal consolidation should not be accelerated as planned if growth does not build momentum even after further monetary and credit easing measures, noting that persistent weak growth that hinders achievement of fiscal targets might also pose risks to credibility". The IMF last week also lowered its expectations for the UK's growth next year to 1.4%, from 2% previously. Policymakers need to take further action to get to grips with the eurozone crisis and to help arrest the slowdown in emerging markets, whose potential to contribute to the global economy may have been overestimated, the organisation warned.
TUC general secretary Brendan Barber said: "Today's alarming health check on the UK economy from the Chancellor's favourite economic experts makes it clear that Plan A is not working." He added: "Continuing along this path could cause permanent damage to the economy."