UK heading for significant downturn, warns OECD

UK heading for significant downturn, warns OECD

In its half-yearly economic outlook, the OECD was particularly downbeat about Britain, predicting that the economy would only expand by 1.8% this year. That rate will drop to 1.4% in 2009 - the lowest since 1992, when Britain was in a deep recession, and half the pace of 2007.

The figures are in sharp contrast to Alistair Darling's budget forecast. The chancellor had said that after a slowdown this year to about 2%, the economy would rebound swiftly to grow by 2.5% next year.

But the Paris-based association thinks otherwise: "A significant down-swing is expected over coming quarters as both investment and consumer demand are damped by tight credit conditions and housing market weakness."

It said financial weakness from the global credit crunch would continue to affect the housing market and investment. It advised the Bank of England to hold off cutting interest rates because of inflationary pressures, which it sees pushing consumer price inflation above 3.5%.

"The Bank now faces an important challenge in getting the balance right between preventing a significant undershoot of the inflation target in the medium term without risking a further drift up in inflation expectations as inflation continues.....continued below

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But the OECD predicts that, with house prices set to fall by 10% next year and spending slowing, the Bank will need to cut interest rates to 4.25% in 2009. The Bank's monetary policy committee announces the result of its latest two-day interest rate meeting today amid widespread expectations that it will leave the Bank rate on hold at 5% again.

"The Bank should delay further easing of policy rates until the risks of provoking additional inflationary pressures have receded and excess capacity in the economy has begun to emerge," said Elmeskov.

The report also forecast that unemployment would rise from 5.4% in 2007 to 5.5% this year and 5.8% next year.

It also warned that its already gloomy forecast had significant risks. "GDP growth could slow more markedly if financial-sector health continues to deteriorate or if the housing market falls into a more significant slump, while high inflation expectations pose upside risks to inflation."

Its forecasts were prepared before the recent Nationwide survey, which showed house prices down 2.5% last month to stand 4.4% lower than a year ago. If this weakness continues prices are likely to fall further than 10%.

The organisation said the slowdown put Gordon Brown's fiscal rules at risk. It projected that the government's budget deficit would rise to above 3.5% of national income next year from about 3% now.

"These figures suggest the sustainable investment rule could be breached in 2009," it said, referring to the Treasury's rule that total public debt remain below 40% of gross domestic product.