Watchdog predicts weakest recovery from the recession

However, the Office for Budget Responsibility also raised forecasts for this year and said the coalition Government had a greater than 50 per cent chance of reaching its deficit goals.

And it lowered its estimate of the number of public sector job losses, to 330,000 from 490,000, after the Government introduced plans to increase cuts to welfare spending.

The OBR said: "Our central forecast is that the economy will continue to recover from the recession, but at a slower pace than in the recoveries of the 1970s, 1980s and 1990s.

"This relatively sluggish medium-term outlook reflects the gradual normalisation of credit conditions, efforts to reduce private sector indebtedness and the impact of the Government's fiscal consolidation", including a hike in VAT to 20 per cent and an 81bn package of spending cuts.

The OBR raised its 2010 growth forecast to 1.8 per cent, from its 1.2 per cent June forecast. The watchdog attributed the strong performance to temporary factors such as unsustainable construction sector activity and companies rebuilding stocks.

The OBR cut its 2011 forecast to 2.1 per cent from 2.3 per cent and its estimate for 2012 to 2.6 per cent from 2.8 per cent.

As growth slows in the near-term, the OBR expects total unemployment to rise to a peak of just over 8 per cent in 2011 – in line with previous forecasts. The watchdog then expects unemployment to fall to just over 6 per cent by 2015.

The OBR also expects the rate of inflation – the cost of living – to be higher in 2010 and 2011 than in its June forecast, but will fall below the Bank of England's 2 per cent target by 2012, as the effects of the VAT hike fade away.

Meanwhile, the watchdog said it expected business investment to bounce back more quickly over the coming quarters.

"We assume that some firms will have put existing investment or asset replacement plans on hold, which will come back on line relatively quickly," it said.

The Government has set out plans to reduce the structural deficit – the gap between public spending and taxes – by 2015-16.

Projections for public borrowing were similar to the OBR's June forecast, as it slightly lowered its estimate in the current 2010-11 financial year to 148.5bn from 149.5bn.

However, the OBR warned that there was considerable uncertainty around its main forecasts, particularly on levels of Government spending and revenue.

"The bottom line from all this is that on current evidence we believe that the government's planned fiscal consolidation is consistent with the medium-term target that it has set itself," OBR chairman Robert Chote said.

Chancellor of the Exchequer George Osborne welcomed the findings from the OBR, which was formed in May to make an independent assessment of public finances and the economy.

He told the House of Commons: "After the deepest recession since the war, the greatest budget deficit in our peacetime history, and the biggest banking crisis of our lifetimes, recovery was always going to be more challenging than after previous recessions.

"But the message from the Office for Budget Responsibility is that Britain's economic recovery is on track. The economy is growing. More jobs are being created. The deficit is falling. Their central forecast is for sustainable growth of over 2 per cent for each of the next five years and employment rising in each and every year."

The forecasts did not take account of the rescue package announced on Sunday for Ireland, Britain's fifth-largest export market, because the deal had yet to be finalised when the watchdog completed its latest report. The banks' exposure to Ireland is around 82bn.