British Economy Close to Recession

The Bank of England will probably lower its GDP forecast, to 1%, as inflation rises to 4%

The Bank of England is expected to deliver a gloomy assessment of the prospects for the British economy when it published its keynote Inflation Report this Wednesday, say economists.

The Bank is expected to lower its forecasts for economic growth once again, heightening fears that the economy may slide into recession, while its projections for inflation are likely to "spike" earlier and faster than predicted in the last Report, in May.

The Bank has already conceded that it is "highly likely" that inflation will exceed 4 per cent this year, with many economists seeing a peak at or around 5 per cent for the consumer price index in September. Bank officials have made it clear in public statements that the size and timing of increases in domestic gas and electricity prices would have a critical effect on their calculations, and most observes have been taken by surprise by the price rises recently announced by British Gas, E.ON and other energy suppliers.

However, the Bank may well take some comfort from the recent easing in oil prices, which will help inflation return to target, perhaps sooner than previously thought.

The official figures for inflation in July, due tomorrow, are widely expected to crest the 4 per cent mark, from 3.8 per cent in June — more than twice the official target of 2 per cent and the worst inflation performance in a decade and a half.

Amit Kara, UK economist at UBS said: "The forecast for GDP will, in all likelihood, be revised lower, perhaps even to show a recession in the second half of this year. At the same time, we expect an upward revision to the CPI inflation forecast for 2008. The peak will probably be in the region of 5.5 per cent. The Bank is unlikely to endorse market expectations of rate cuts over the next 12 months."

If the Bank of England does drastically reduce its growth forecast, it will make it still more difficult for the Chancellor, Alistair Darling to resist following suit when he comes to publish his own official projections in the pre-Budget report in October.

Lower growth assumptions for 2009 — closer to 1 per cent than the 2.5 per cent currently expected by the Treasury, and the 1.5 per cent previously pointed to by the Bank — will, in turn, make it much more difficult for the Government to meet its fiscal rules. These may well be fudged or relaxed in response to the unprecedented conditions induced by the credit crunch.

The Bank of England is not alone in its pessimism. The director general of the CBI, Richard Lambert, said over the weekend that there was "no doubt that the mood has darkened in the last two or three months", admitting that forecasters including the CBI had been "over-optimistic" about the resilience o f the economy. He said: "A year ago, it seemed reasonable to hope that the worst would be over by now. That has not turned out to be the case".

Mr Lambert pointed to the slumps in business confidence and the property market and the continuing credit crisis as reasons why "most analysts are now suggesting that the economy will, at best, only manage to stagnate in the coming few quarters, and that the growth prospects through 2009 and into 2010 look no better than anaemic".

While the Bank's predictions are expected to be unwelcome to ministers still trying to sound upbeat abut the faltering economy, they are unlikely to echo the stiff criticism made of Mr Brown's performance as Chancellor by Mr Lambert: "Years of unsustainable increase in public spending... have left the public finances in poor shape to cushion these adverse shocks".