George Osborne Mervyn King
Chancellor George Osborne and Governor Mervyn King are under pressure to act amid an ever-weakening UK economy (Reuters)

Britain's economy will see near zero growth for 2012, according to slashed Bank of England growth forecasts, as the recession deepens and more pressure is put on the beleaguered Chancellor George Osborne.

Inflation should fall to below the government's 2 percent target at some point in 2013, said the Bank of England's Quarterly Inflation Report, but growth will be flat across this year as continued uncertainty from the eurozone weighs heavily on the chances of a recovery.

"The outlook for UK growth remains unusually uncertain," said the Bank's report.

"The greatest threat to the recovery stems from the risk that an effective policy response is not implemented sufficiently promptly in the euro area to ensure that the adjustments in the level of debt and competitiveness required by some member countries occur in an orderly manner."

The UK economy was predicted to grow by 1.2 percent in 2012 by the Bank of England at the start of the year, but this is the second downgrade in its forecasts this year.

Britain plunged even deeper into recession with a sharp -0.7 percent contraction of GDP in the second quarter of the year, as record rainfall drowned an already foundering economy and lost production from an extra day off for the Queen's Diamond Jubilee proved a significant drag.

GDP has been contracting ever since the last quarter of 2011, when a sharp drop in construction sector output punctuated an overall -0.3 percent decline in Britain's economy.

It was a similar story in the first quarter of the New Year, when once again falling output from the construction industry held the economy down to another -0.3 percent contraction.

UK government austerity questioned

Since the Conservative-Liberal Democrat coalition took office after the May 2010 election failed to produce any single majority government, it has pursued billions of pounds of public budget cuts in its attempt to erase a deficit left behind by the outgoing Labour administration, which had been in power for 13 years.

These swingeing cuts to public services are necessary, argues the government, to balance the country's finances and supposedly restore Britain's "fiscal credibility" and keep a lid on borrowing costs by maintaining investor trust that they will get their money back.

Any adding to the country's debt through extra public spending would be irresponsible, the government says, and it has stubbornly committed itself to the "no alternative Plan A" of austerity as a means of paying down the deficit.

Critics say that this is a time when fiscal stimulus is needed to grow the economy and create jobs, both in the public and private sector, with the additional tax revenues and increase in output used to clear Britain's budget deficit.

As the economy contracts and tax receipts for the Treasury fall, the UK's debt-to-GDP level has soared to 66.1 percent, its highest rate for over forty years.

Eurozone crisis weighs on UK

On-going crisis in the eurozone, the UK's biggest trading partner, looms over the chances of an economic recovery.

Both the Bank of England and the Treasury have blamed uncertainty in the single currency area, and the ever-present chance of a break up should the crisis remain unresolved for much longer, on holding back the UK economy.

British banks have risk exposure to the eurozone and face the prospect of billions more in losses should any major state default on its vast debts, potentially triggering other defaults across the area.

Across the eurozone, governments are imposing stringent austerity measures on their populations to show bond markets that they are committed to bringing public finances under control.

Some of the biggest economies, such as Italy and Spain, have flirted with 7 percent bond yields on 10-year government debt, considered a benchmark of unsustainability and the point at which a bailout is needed, as wary investors doubt the stability of some states' finances.

As public anger rises against austerity, it is becoming ever-more politically difficult to implement public sector cuts in the eurozone - increasing the risk of an eventual default.

Fears are that there is not enough money to fully bailout major economies if they needed it, meaning any default would be catastrophic not only for the eurozone, but anyone who has cash exposed to the area.

Slowing growth in India and China hurts UK exports

Elsewhere in the world fast-growth emerging economies such as India and China have seen their expansion ease in recent months.

Osborne has said he wants to increase the total value of UK exports to £1tn by the end of the decade, but slowing growth in the world's biggest economies, eyed by the chancellor as potentially lucrative markets for ailing British manufacturers, puts up a hurdle in front of this ambition.

Manufacturers have reported a collapse in new business orders, with no sign that demand will pick up any time soon.

UK inflation falling fast

Inflation has been falling sharply in recent months, dropping to 2.4 percent in June, and is set to fall further still, passing the government's 2 percent target.

A high cost of living - which saw price inflation peak at a crippling 5.2 percent in September 2011 - and stagnant wage growth have eroded households' disposable income.

This has hit retailers particularly hard, as hard-pressed consumers tighten their spending to weather the wider economic storm and focus on paying for essentials, such as energy bills and food.

However despite the falling headline rate of inflation, analysis of the data by IBTimes UK shows that many everyday items have actually increased in price or stayed the same.

Wobbles over Q3 bounce-back

Many economists are predicting a bounce-back for GDP in the third quarter because of a positive base effect from poor comparative data, falling inflation and rising wages, and a boost from the London 2012 Olympic Games.

However private industry data for July, the first month in the third quarter, casts a shadow over the optimism.

Manufacturing output continued to contract, hitting a 38-month low.

Construction sector activity returned to marginal growth, but this was seen as disappointing given the positive comparative position it was in, off the back of a two-year low in June with the disruptive effect of the Queen's Diamond Jubilee.

Most worryingly for the government the UK's service sector, the powerhouse of the economy representing around three quarters of GDP, saw growth slow to a 19-month low in July.

Heavy discounting to combat dampened consumer demand and rising input prices squeezed service sector margins, while wet weather and pre-London 2012 disruption also weighed heavily on the service sector.

BoE ups policy efforts with credit easing schemes

Bank of England policymakers, backed by the Treasury, have launched two credit easing schemes in the hope that affordable credit will be freed up from small and medium sized businesses, who they believe are in desperate need of finance but risk-fearing banks are not obliging the demand.

The Funding for Lending Scheme (FLS) sees banks offered cheap loans in direct correlation to the amount they lend to the real economy of consumers and businesses - the so-called "real economy".

As a bank's lending to this sector of the economy increases, so does the value of discount rate loans they can access from the Bank of England.

Mervyn King, Bank governor, said that this offers a "significant financial incentive" for British banks to increase their levels of affordable lending.

A second scheme, known as the Extended Collateral Term Repo (ECTR), sees the Bank of England accept low-quality assets, such as credit card debt, as security in loans that have a cheap rate.

This means banks can borrow money more cheaply against bad collateral than they would be able to in the interbank lending market.

Until it is clear what effect these policy efforts have had on the UK economy, the Bank is unlikely to cut its base rate further - as it has been called on to do by the International Monetary Fund (IMF) - or print more money in its quantitative easing (QE) programme.

Currently its QE programme stands at a total value of £375bn, as it purchases hundreds of billions of pounds worth of gilts in order to improve market liquidity and free up cash on business and bank balance sheets.

It was hoped that this new-found fast money would then be used by banks to increase lending and by businesses on expansion, to create new jobs and boost output.

However a report by Ernst & Young, the accountancy firm, revealed that many businesses were simply hoarding the money gifted by QE, rather than investing it - showing the Bank's QE policy as ineffective.

Critics of QE also say that the Bank of England is risking its progress on bringing inflation down by printing more cash.

Government offers infrastructure investment boost

In a sign that the government's defence against the anti-austerity critics is weakening, it recently announced two taxpayer-backed infrastructure investments.

The first sees a £9.3bn fiscal investment in Britain's railways, to upgrade lines and stations. The second, called the UK Guarantees Scheme, sees taxpayers underwrite billions of pounds of major infrastructure projects that are struggling to find financing.

Danny Alexander, the chief secretary to the Treasury and Osborne's most senior deputy, hinted that there may be more fiscal stimulus to come when he said the UK's AAA credit rating is "not the be all and end all".

In the past the government has hailed its AAA status, gifted by credit rating agencies, as vindication of its austerity programme, stressing the importance of retaining this endorsement of Britain's public finances.

However any fiscal boost for the UK economy would undermine the government's own economic policy, to the point where some will say it has failed, and likely lead to a credit rating downgrade.