Households must not rule out the prospect that the UK's economy shrinks by between 5 per cent and 10 per cent next year if the financial crisis sets off an even more vicious cycle of cutbacks, according to the Centre for Economics and Business Research.
The warning comes only days after the Office for National Statistics announced that gross domestic product contracted by 0.6 per cent in the third quarter - worse than it previously estimated and the weakest quarterly figure since the early 1990s recession. Although Alistair Darling indicated in the pre-Budget report that the slump would be less severe than in the early 1990s, a growing majority of economists are now warning that the scale of the downturn could be almost unprecedented. Capital Economics and Bank of America have predicted that the economy will shrink next year by the biggest amount since 1947 - one of the worst recessions Britain has ever experienced, following Second World War demobilisation and one of the coldest winters on record. However, Ben Read of the CEBR warned that the scale of the recession could be even more severe. "It is easy to see that things could be even worse," he said. "Despite the public declarations by the Government that the banks ought to be lending more, it is clear that the primary concern of many of our largest banks is to shore up their balance sheets and, for those on the end of government bail-outs, to pay back their Treasury paymasters. "With few incentives for banks to behave otherwise, credit availability to businesses may become even worse during 2009. At the same time, businesses are already starting to become entrenched in a deflationary mindset where investment budgets are curtailed not only because budgets are tight, but also because prices are falling." With companies facing major pressure on their balance sheets, they look likely to slash their investment budgets, in so doing cutting staff numbers and wage bills next year. If this combines with a sudden sharp increase in the rate at which consumers save rather than spend, the result could be that a major chunk of UK economic output is lost, he said. "If this deleveraging scenario occurs, a contraction of between five and ten per cent could be on the cards, setting the United Kingdom economy back by five years," he said. Although such an outcome is less likely if the Bank of England slashes rates even further in the coming months. The Bank is expected to reduce borrowing costs beneath 2 per cent next month for the first time in its 314-year history, and many suspect it could reduce them to zero before the summer. Economists also fear that house prices, which have fallen by around 15 per cent already this year, could drop a further 15 per cent or 20 per cent next year as the number of redundancies climbs further.