In the clearest warning yet from an international agency that the UK economy is in trouble, the IMF said the government needed to act quickly to bolster consumer and business confidence and spur growth. Government action was also needed to avoid the worst effects of the euro crisis and the likelihood of further falls in property values, it said.
In a grim assessment the IMF concluded: "Recovery has stalled. Post-crisis repair and rebalancing of the UK economy is likely to be more prolonged than initially envisaged. Confidence is weak and uncertainty is high."
Labour leaped on the report, describing it as a devastating critique of George Osborne's lack of action during the past two years of coalition government.
The chancellor also faces pressure from business lobby groups frustrated at the lack of impetus from Downing Street to tackle the banks' reluctance to provide affordable loans.
GDP figures next week are expected to show the UK was still in recession in the three months to the end of June and has flatlined for two years.
Retail spending figures increased by just 0.1% last month, despite hopes of a bigger fillip from the jubilee, while surveys of the major sectors of the economy have weakened since the beginning of the year. The manufacturing and construction sectors have contracted while the services sector, which accounts for around 70% of the economy, has failed to grow.
Probably most worrying for the government is the state of bank lending after figures from the Bank of England showed a return to the trend last seen in the aftermath of the financial crisis in 2009.
The Bank said lending to businesses declined by £3bn, with small and medium-sized businesses hit especially hard in the three months to May. Mortgage approvals by UK lenders were broadly unchanged. The IMF said ministers needed to strengthen bank reserves to support lending. It said banks were seeking to bolster their finances by jettisoning loans and shrinking their balance sheets, which would harm their capacity to lend to businesses and homebuyers. Instead banks should be increasing their reserves to allow for greater lending. It also said the government was in a safe position to loosen the purse strings and relax some plans to cut spending.
Ed Balls, the shadow chancellor, said the IMF had warned in previous reports that public spending cuts and a lack of infrastructure projects were damaging the recovery, but had been ignored.
"This is a very serious warning to the chancellor that urgent action to boost jobs and growth is needed. With Britain now one of just two G20 countries in a double-dip recession [with Italy] and long-term unemployment rising, how much worse do things have to get before the chancellor finally changes course?" he said.
Osborne recently announced £40bn to support infrastructure spending on roads, rail and communications links, but most of the money is only available in the form of guarantees for private sector projects.
Ministers believe the guarantees can unlock projects logjammed by a clampdown on bank lending. However, infrastructure spending will take several years to take effect. In recent weeks, the Treasury has backed a Funding for Lending scheme run by the Bank of England that gives high street banks and building societies a substantial incentive to increase their lending.
The IMF said: "The economy is expected to grow modestly, but with current policy settings the pace will be insufficient to absorb significant slack in the economy, raising the risk of a permanent loss of productive capacity."
Ed Balls said the government initiatives were half hearted and not enough to pull the economy out of a decline.
"According to the IMF, Britain has the space to adopt a more balanced approach to spending cuts and tax rises to support the jobs and growth we need. Rather than waiting for things to get worse, David Cameron and George Osborne must act now to get the economy moving, get people back to work and so get the deficit down"
The Treasury said: "Today's report is just the detailed version of the IMF's assessment of the UK economy made in May. The IMF have repeated their advice that Britain's fiscal plans are appropriate, that we are right to support the economy through monetary and credit easing as well as government guarantees for infrastructure, and that the uncertainty and instability in the eurozone is the 'overarching risk' to the British economy."
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