As gloom deepens, it's time for policymakers to act

After the US debt debacle and downgrade, and the continued failure of euro area politicians to get to grips with the sovereign debt crisis - not to mention the riots here in England - what we really wanted to see in this week's slew of economic data was some good news. Unfortunately, we got anything but that.

With CPI inflation ticking back up in July, and large increases in gas and electricity prices looming in the next few months, it is still looking like inflation will hit 5% this year. That will put even more pressure on consumers, who are already keeping a tight grip on their purse strings, as shown by yesterday's retail sales numbers. As the economy inches towards rebalancing, with little sign of investment and net exports seriously picking up the baton of growth, there is a real chance of a double-dip in the months ahead if consumers say enough is enough.

To make matters worse, the labour market - one of the brighter spots on the economic front - is also showing signs of deterioration. The unemployment rate rose to 7.9% in the second quarter, and the July increase in the timelier claimant count measure does not bode well. And although 8% unemployment is arguably a better outcome than many would have predicted, given the deepest post-war recession that most people can remember, the headline data have masked substantial underlying weakness.

In particular, there has been a big rise in the number of people who have been forced to take part-time or temporary work because they cannot find full-time permanent posts. If we add these to the workless total, as well as those who would like a job but are not classified as unemployed, then underemployment in the UK is about 6.5 million, compared with the official unemployment figure of 2.5 million. And those who still have jobs have seen meagre pay increases since the recession hit, even before high inflation eroded their purchasing power.

With even average economic growth looking like an optimistic forecast for the next couple of years, the real risk now is that these underlying weaknesses in the labour market come to full bloom. Prolonged unemployment would deepen the economic scars that the UK already bears from the banking crisis and recession. And that really matters because we risk losing years of growth that may never be fully recaptured.

Yet, there is little sign of any help from policymakers. The Government is sticking rigidly to its deficit-reduction plan, even with a growing chorus of reputable institutions pointing out that targeted short-term measures would not damage the UK's fiscal credibility. And although the Monetary Policy Committee is again unanimous in keeping interest rates at record lows, Adam Posen is a lone voice in calling for further stimulus.

The Bank of England's Andy Haldane also sees the risks, noting that the new Financial Policy Committee needs to cushion falls in credit. But, for now, both appear to be in the minority. Policymakers seem willing to sit "behind the curve", at best reacting to events rather than anticipating them. Although this crisis started in the banking sector, economic mismanagement is now the biggest danger facing the UK economy.

Colin Ellis is chief economist at the British Venture Capital Association.