Page last updated at 10:17 GMT, Sunday, 19 July 2009 11:17 UK

Economic recovery in UK 'on hold'

Builders on a construction site
Weaker construction activity has hit the economy

The UK economy is set to shrink by 4.5% in this year, the biggest fall in a single year since 1945, according to an influential think tank.

The downbeat forecast is more pessimistic than the consensus view, and considerably worse than the 3.5% fall predicted by the government.

The Ernst & Young Item Club also warned that hopes of economic recovery are "running ahead of reality".

The Item Club also warned of the threat posed to the economy from swine flu.

If doomsday predictions about the extent of the flu outbreak materialise, it forecast a further 3% contraction in GDP this year, on top of the 4.5%.

The flu could also wipe out any growth next year, with a worst case scenario of a further 1.2% contraction.

The Item Club also predicts that UK interest rates will be kept at their current level of 0.5% well into next year.

'Chance of relapse'

"Unfortunately, it is hard to see any very solid grounds for sustained optimism at the moment," said Professor Peter Spencer, chief economic adviser to Item.

It remains unclear how quick and complete recovery will be, and there is still a serious chance of relapse
Professor Peter Spencer, Ernst & Young Item Club

"The economic patient has been in trauma, but thanks to the paramedics at the Treasury and the Bank of England who pumped billions of pounds worth of medicine into the economy, the patient has stabilised for now," he added.

But any recovery could be short lived, he warned.

"It remains unclear how quick and complete recovery will be, and there is still a serious chance of relapse."

Indeed some analysts believe that, despite hopes the worst of the downturn may be behind us, there could be a so-called "double dip" recession, where the economy stabilises before contracting again.

The only "ray of hope", said the Item Club, is a recovery in world trade, which UK exporters would be able to exploit due to the weak pound.

Lack of lending

The main reason for the gloomy outlook, the club said, was the fact that banks are still not lending enough to boost the economy.

"There is currently little sign of any extra lending to either companies or consumers. Banks are saying that they will expand lending more aggressively over the next three months, but it seems unlikely that they will be able to meet the demand for credit," argued Professor Spencer.

Last week, the International Monetary Fund published its latest report on the UK economy, in which it forecast economic activity to shrink by 3.75% this year.

The Ernst & Young Item Club publishes its full summer forecast on Monday 20 July.



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