OECD expects 'subdued' UK recovery in 2011

The UK's economic recovery slowed in the second half of last year and will remain 'subdued' throughout 2011, the Organisation for Economic Co-operation and Development (OECD) predicts.

In its latest UK Economic Survey, the organisation highlights fiscal tightening measures and a fading rebound in world trade as reasons for the slowdown.

"Fiscal consolidation will impact significantly on government consumption and investment, but is also reducing household income growth through tax increases.

"Slow real income growth will continue to hamper household consumption even though deleveraging pressures have eased as house prices and overall wealth positions have stabilised and saving rates recovered."

The report also criticises the UK's 'inefficient' VAT system, describing it as one of the worst among member nations.

"Ending exemptions and increasing lower rates would provide a more efficient system and raise more revenues," it reads.

The OECD also notes the upcoming overhaul of the financial regulatory system and warns of the potential problems this could create.

"An inevitable consequence of the proposed institutional arrangement is the concentration of power with the Bank of England (BoE).

"The risks associated with such a concentration will be mitigated by the presence of external members on the Financial Policy Committee.

"Still, the Bank will need to be as transparent as possible on financial regulation, and it will be critical to ensure effective co-ordination between the BoE and other authorities, including the Financial Conduct Authority, the Treasury and supra-national entities."

Despite the above-target inflation rate, the OECD does back the BoE's monetary policy, arguing it should remain expansionary in order to support the recovery.

It adds: "Policy rates should rise only slowly from mid-2011 onwards as long as inflation expectations do not drift too far from the target.

"QE should be withdrawn in an orderly and pre-announced fashion once policy rates have risen from their current low level.

"The BoE will, however, need to react sooner if inflation expectations begin to rise considerably or feed through to significant wage increases."

The OECD also makes recommendations in the area of banking to prevent another crisis, suggesting the separation of commercial from investment banking.

"An alternative to breaking up banks is to build a "firewall" between higher risk investment banking and commercial banking by promoting non-operating holding company structures," it says.