Page last updated at 11:50 GMT, Tuesday, 25 November 2008

UK to suffer 'severe' recession

Closing down sale sign
The UK economy is likely to go into a deep recession next year

The Organisation for Economic Co-operation and Development (OECD) has warned of a "severe" economic downturn in the UK in 2009.

The Paris-based body has predicted that economic output in the UK will fall by 1.1% next year, more than any other major G7 country.

Unemployment in the UK is predicted to rise significantly to over 8% by end of 2009 from 5.5% in 2008.

The US economy is forecast to decline by 0.9% in 2009, and Germany by 0.8%.

Economic growth in the 30 countries of the OECD is forecast to fall by 0.4%, before growing by 1.5% in 2010.

The downturn is likely to be the most severe since the early 1980s leading to a sharp rise in unemployment

As well as the UK, the OECD identifies Hungary, Iceland, Ireland, Spain and Turkey as being the countries most affected by the economic slowdown.

"These economies are most directly affected by the financial crisis, which in some cases exposed other vulnerabilities, or by severe housing downturns," it says.

UK: -1.1%
US: -0.9%
Germany: -0.8%
France: -0.4%
Italy: -1.0%
Canada: -0.5%
source: OECD (% change in GDP)

In the pre-Budget report, the chancellor accepted that the UK economy would decline by 0.75% to 1.25% next year, but said that the UK was "better placed" than other countries to cope with the downturn.

Government spending

The OECD has endorsed the need for government spending in affected countries to boost growth, because it says that interest rate cuts are no longer effective.

"Against a background of deep economic downturn, additional macroeconomic stimulus is needed," it says.

"Current conditions of extreme financial stress have weakened the monetary transmission mechanism. In this unusual situation, fiscal policy over and above the support provided through automatic stabilisers [such as unemployment benefits] has a role to play."

But it warns that "the scope for easing is limited in countries that start from a weak fiscal position," and warns of the risk of "adverse financial market reaction" unless there is a credible framework for reducing budget deficits in the medium-term.

It forecasts that budget deficits throughout the OECD area will widen from 1.4% of GDP in 2007 to 3.8% in 2009.

In the UK, the OECD says that the fiscal risks are greater because of the costs of the bank bail-outs.

Worldwide slowdown

The OECD warns that any recovery in the US is likely to be "languid" as consumption is held back by the large losses in household wealth.

And it says that the risks are still on the downside, suggesting that economic conditions could worsen significantly.

These risks include "further failures of financial institutions," a "longer period before financial conditions normalise," and the possibility that emerging market countries such as China will be harder hit by the downturn in global trade.

And it adds that when downturns are caused by banking crises, "the recovery is typically more anaemic than usual."

The OECD says the downturn is the "most severe since the early 1980s" and is likely to lead to a "sharp rise in unemployment" with growth not returning to trend before the second half of 2010.

World trade growth will also slow sharply, from 4.8% this year to 1.9% in 2009, which will hit many major developing countries.

However, the slowing economy, and the effect of lower commodity prices, will bring about a sharp slowdown in inflation, leaving space for more cuts in interest rates.

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