UK economy shrinking at fastest since 1931

The economy is expected to decline more sharply in 2009 than at any time since 1931 and is already contracting faster than in the early 1930s, according to the National Institute for Economic and Social Research.

The NIESR, issuing its quarterly economic outlook for the year, predicts that national income will decline by 4.3 per cent this year – much more than the 3.5 per cent forecast by Alistair Darling, the chancellor, in last month’s Budget, and even more than the 3.8 per cent estimated by the European Commission.

The gloomier assessment – the NIESR predicted contraction of 2.7 per cent for 2009 just a few months ago – is due to the unexpectedly sharp fall in global trade, which is hitting UK manufacturing with particular ferocity.

The NIESR’s central projection is for successively lower levels of contraction for the second and third quarters of this year, with modest growth in the final months. Consumer spending is likely to be brought forward somewhat by households hoping to beat the deadline when value added tax will revert to its higher level, it says.

“World trade has collapsed by more than forecast,” said Simon Kirby, economist at the NIESR. “If net trade fails to pick up, we could see a second year of economic contraction.”

Government debt would rise to about 100 per cent of gross domestic product – much more than the Treasury was projecting – and output would be permanently scarred by 4-5 per cent.

National output was not likely to return to its peak in the first quarter of 2008 until the first three months of 2012, with a peak-to-trough decline of 5.5 per cent. On a per capita basis – adjusted for population – this means the contraction in output will be sharper even than that seen in the recession of 1979-81.

Unemployment, however, while likely to peak at more than 3m in 2011, would remain lower than during the recession of the early 1980s when population growth was taken into account. That was because wages have fallen sharply in order to preserve jobs.

The NIESR’s estimates cast doubt on the chancellor’s fiscal projections, which require much higher levels of economic activity than the institute expects. For example, in order for the chancellor’s forecasts of tax revenues to prove accurate, housing activity would have to return to its levels of 2002-03 at the height of the housing boom.

The NIESR no longer expects to see deflation this year as measured by the consumer price index. A weaker pound was driving up prices of imported goods, it says, and recent rises in oil prices were likely to prop up prices.