The UK economy could shrink by as much as three per cent this year as the growing recession takes a heavy toll on jobs, manufacturing, exports, the housing market and consumer spending.
That’s the gloomy new year prediction today from Howard Archer, economic forecaster at IHS Global Insight.
And with the world facing possibly the worst downturn in activity since World War Two, the UK’s plight could be even worse, he stressed.
In a wide-ranging analysis of prospects for 2009, Mr Archer claimed the government underestimated the downturn and the amount it will need to borrow to keep the UK afloat.
“We expect the UK economy to contract through 2009, with the decline in GDP [gross domestic product] particularly sharp in the first half,” he said. “GDP is forecast to contract 2.7 per cent in 2009, following estimated growth of 0.8 per cent in 2008.”
Mr Archer said the assumption is based on an expected one per cent contraction in the fourth quarter of 2008.
“The plethora of bad data and survey evidence relating to retail sales, unemployment, service sector activity, manufacturing output and construction activity highlight the economy has taken a major turn for the worse after contracting by 0.6 per cent quarter-on-quarter in the third quarter.
“Survey evidence relating to employment and business investment intentions make for very sorry reading.
“By the end of 2009, GDP is forecast to be 3.7 per cent below the peak seen in the first half of 2008. GDP is forecast to expand just 0.2 per cent in 2010 as recovery develops gradually through the year. We consider there to be significant downside risks to these forecasts as the global economy is facing its most serious recession since the Second World War.
“It is possible the UK economy could contract more than three per cent in 2009 and see further contraction overall in 2010. Consumer spending is being hammered by accelerating unemployment, muted income growth, high utility bills and food prices, very tight lending, heightened debt levels, a depressed housing market, and substantially lower equity prices.
“Heightened concerns about the economic outlook are leading consumers to tighten belts.”
However, the recent cut in the Bank of England’s base rate from five per cent to two – with the prospect of more reductions – will help consumers, as will measures in the government’s £20billion economic stimulation package in November’s pre-Budget report.
Inflation will “retreat sharply” over coming months, helped by reduced VAT. “Nevertheless, consumers will face serious pressures for an extended period, and will be particularly hit by sharply rising unemployment in 2009,” added Mr Archer. “We expect consumer spending to contract around two per cent in real terms in 2009.”
Mr Archer said business investment will fall substantially in the face of weaker final demand, increasing capacity, worsening cashflows, depressed confidence, tight credit and falling profits. The construction industry will be particularly hard hit.
Despite benefiting from a markedly softer pound, exports will be limited by muted global growth, especially recession in the eurozone and US although a fall in imports will help the UK’s trade balance marginally.
Mr Archer also predicted a “very real likelihood” of deflation in the UK in 2009 as prices and wage settlements fall and outweigh the otherwise inflationary effect of a weak pound.
“We expect the Bank of England to deliver another hefty interest rate cut in January,” he added. “Further out, we expect interest rates to fall to a low of 0.5 per cent by spring 2009 and stay there for the year. However, it is far from inconceivable interest rates could come all the way down to zero.”
It is possible the Bank of England will pump more money into the economy – “quantitative easing” – to counteract the downturn in 2009.
Mr Archer said there can be “absolutely no doubt” unemployment will rise sharply higher, possibly to two million in 2009 and three million the year after.
“Reports of companies laying off workers are becoming more and more prevalent, while an increasing number of companies are folding,” he said.
The outlook for the housing market remains bleak with Global Insight pencilling in a further 15 per cent fall in prices in the year ahead.
But Mr Archer says the signs are the fall in the pound may be near to bottoming out, although it is unlikely to see a major recovery in 2009.
“Both the US and the eurozone face difficult outlooks, and we are far from convinced enough bad news is factored into the euro.”
On the UK government’s finances, Mr Archer said: “While alarmingly high, the government deficit projections contained in November’s pre-Budget report are very likely to be missed by a substantial margin as the recession looks certain to be significantly deeper and longer than the government forecast.”