Page last updated at 10:50 GMT, Monday, 20 October 2008 11:50 UK

UK economy 'already in recession'

Hetal Mehta from the Ernst and Young Item Club predicts further economic decline.

The UK economy has "deteriorated dramatically" in the past three months, and is already in a recession, top forecasters have suggested.

The Ernst & Young Item Club says the economy will shrink by 1% next year, before growing by 1% in 2010.

The Item Club's chief economist, Peter Spencer, told the BBC: "Recession is already baked in the cake."

But one "bright spot" is that inflation is likely to fall, enabling the UK to cut interest rates further.

Bank bail-outs

In other developments:

  • Mortgage lending in the UK fell to its lowest level for more than three and a half years during September, the Council of Mortgage Lenders said. A total of 17.7bn ($30.9bn) was advanced during the month, 10% less than during August and 42% below the level for September last year.
  • UK government borrowing soared to a record high in September, with net borrowing rising to 8.1bn - the highest for more than 60 years, according to the Office for National Statistics
  • Sweden became the latest European government to announce a bank rescue plan. Its $205bn package included credit guarantees and a bail-out fund
  • The chairman of French savings bank Caisse d'Epargne has quit over the loss of 600m euros (466m) in a "trading incident"
  • Dutch banking and insurance company ING is to receive a 10bn euro ($13.4bn; 7.7bn) government cash injection
  • The head of the European Central Bank said the bank would do whatever was necessary to boost market confidence
  • South Korea revealed its own financial sector rescue package, worth $130bn
  • Figures showed China's economy has continued to slow. Growth fell for the third quarter in a row - down to 9% in the three months to September

Rising unemployment

In its forecast for the UK economy, Ernst & Young said that company profits had already been damaged by very high commodity prices.

While recent actions taken by the government to shore up the banking system were welcome, the credit crunch would hit the economy "very hard", it warned.

Mr Spencer said: "Even if equity markets stabilise and we begin to see capital flowing around the international financial system again, we are still looking at a domestic and global economy that will be in recession for the next 12 months."

However, Ernst & Young forecasts that with plunging interest rates, falling inflation, and a fundamentally strong economy, the recession will be "relatively short and shallow".

We desperately need a global solution given the heavy dependence of our banks and borrowers on cross-border banking flows

Peter Spencer, chief economist, Ernst & Young Item Club

The group is not alone in thinking the UK has entered a recession - which is typically defined as two quarters of negative growth.

A recent quarterly survey of 5,000 businesses by the British Chambers of Commerce (BCC) also said the UK was in a recession.

Companies are likely to see their profitability squeezed further, prompting firms to invest 5% less in 2009, the Item Club predicts.

'Deep freeze'

As a result of the slowdown, widespread cuts in investment and employment are "inevitable".

While the largest job cuts so far have been in finance and housing - the sectors most closely linked to the recent turmoil - the effect will spread further.

The Item Club said it expected unemployment claims would hit 5% by the end of 2009, double the rate at the end of 2007.

The report comes after recent data from the Office for National Statistics underlined the weakening labour market.

The number of people out of work in the UK rose sharply in the three months to August by 164,000 compared with the previous quarter, marking the biggest rise for 17 years.

Banking losses - comparison of crises

Until September, accelerating inflation had been a major concern - the most recent figures showed the annual CPI rate had reached a 16-year high of 5.2% last month.

But prices have fallen recently, most notably for energy, and analysts expect September's figure to mark a peak.

However, the Item Club said real disposable incomes were set to remain flat in 2009, before rising in 2010.

The research group forecasts that consumption will fall by 1.2% next year, with credit continuing to be hard to obtain and unemployment expected to rise.

The Item Club predicts house prices will fall 14% by the end of this year, and drop a further 10% next year.

Until the bottom of the market is reached and confidence returns the housing sector will be in "deep freeze", it says.

Fiscal policy

"Last year consumers were able to handle the income squeeze by borrowing and dipping into their savings," said Mr Spencer.

But this year "it is a very different story with credit harder to access and far more expensive".

The Item Club said recent government intervention had pulled the UK back "from the brink" but the banking system was "in intensive care".

Earlier in October the UK government set out a number of initiatives to rescue the banking system by making 400bn available.

But the report said that addressing problems in the UK's finance system could not be dealt with in isolation.

"We desperately need a global solution given the heavy dependence of our banks and borrowers on cross-border banking flows".

Longer term it said the recent financial crisis had left huge question-marks over bank regulation and governance, as well as fiscal policy.

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