The UK economy will decline by 1% next year, but if the US and UK banking rescues fail to work "we could be in for a depression".
The UK economy will decline by 1% next year, but if the US and UK banking rescues fail to work "we could be in for a depression".
That is the latest grim outlook from Ernst & Young's Item Club, the only major forecasting group to use the Treasury's model. Its best-case scenario is a weak recovery to growth of 1% in 2010.
"The outlook for economic growth has deteriorated dramatically over the last three months," says the club's autumn report published today, adding: "Recent government rescues may have pulled us back from the brink, but the banking system remains in intensive care."
Whether cutting interest rates would work "depends critically on the success of the (US Treasury secretary Hank) Paulson plan, which is by no means assured ... we need this plan to work quickly", it says.
Item Club says that in view of the problem of valuing banks' assets, and the looming recession, "it is not clear that the £37bn recapitalisation will be sufficient to keep the banks going".
It adds: "Moreover ... the funding gap - our reliance on wholesale bank deposits to make up for the paucity of domestic deposits - will be much more difficult to solve. That is because it is a reflection of the deep-seated macroeconomic imbalances in the world economy, and in particular the high level of borrowing and the low level of saving in the UK.
"Incredibly, the chancellor flagged this problem up in the budget, but has only just got around to doing something about it."
Long-term, savings had to be rebuilt. Meanwhile, "the Treasury's £250bn of guarantees for new inter-bank borrowing will help, but may not be sufficient if the US banking markets remain frozen".
On the looming recession, the report says: "The downward momentum in the housing market will be difficult to arrest and is spreading to other sectors."
The findings come as research from ratings agency Standard & Poor's shows 60,000 homeowners a month are being pushed into negative equity.
At that rate, two million households would enter negative equity by 2010, more than the 1.8 million in the 1990s.
The Item Club report predicts that unemployment will hit 2.2 million next year.
The club's chief economic adviser, Professor Peter Spencer of York University, warned that equity markets would stay under pressure from the sell-off by hedge funds.
"For the foreseeable future, pretty much every time the markets bounce, it will be a dead cat bounce," he said.
"I suspect it will actually move sideways for the next two years."
The report says one positive for the UK economy is that inflation will fall, allowing interest rates of 3% by next summer and a fall in the pound.
The report warns: "Longer term, this episode will leave huge question-marks hanging over bank regulation and governance, as well as fiscal policy."
Public borrowing was now in need of "a more objective medium-term framework, one which cannot be fudged so easily but gives the Treasury time to restore the public finances to robust health".
Government borrowing looked set to rise to £60bn this year, against a forecast £43bn, and to £92bn next year, or 6.1% of GDP.
"The net national debt will exceed 40% of GDP next year even if the effect of the Northern Rock and prospective investments in banking markets are put to one side."
