IMF makes gloomy forecast for UK economy

4.15pm BST update




* Heather Stewart in Washington
* guardian.co.uk,
* Wednesday April 9 2008

Alistair Darling's prediction that Britain will bounce back from the credit crunch by next year looks hopelessly optimistic, according to an authoritative assessment of the crisis by the Washington-based International Monetary Fund.

In its twice-yearly World Economic Outlook, the IMF warned there is a one-in-four chance of a full-blown global recession over the next 12 months.

Against this gloomy backdrop, the UK, with its debt-laden consumers and shaky house prices, looks especially vulnerable. Just a month ago, in the budget, the Treasury pencilled in GDP growth of 2% this year, and a healthier 2.5% in 2009, as the economy recovers; but the IMF today forecast much weaker 1.6% growth for both this year and next.

Alistair Darling has been pinning his hopes on a rapid resolution of the turmoil that has gummed up the credit markets and cut the supply of lending. But the IMF's report paints an alarming picture of an unfolding crisis that will take a long time to resolve. The mortgage crisis in the US is now "the largest financial shock since the Great Depression," it said.

In the UK, the chancellor has repeatedly insisted that the economy is "better-placed" to weather the storm, because of its flexible labour market and low unemployment. But the IMF calculates that Britain's housing market is overvalued by up to 30%, and could be destined for a damaging correction.

House prices are already falling – by 2.5% last month alone, according to the Halifax – and the IMF believes the wider economy will be hit hard over the next two years, as overstretched banks repair their balance sheets, and ordinary borrowers face higher interest rates and tighter loan conditions.

"Certainly the housing market is going to be a drag on the economy," said senior IMF economist Charles Collyns. "We do see house prices softening already, and we see potential that the housing correction will continue, with an impact on consumption. We also see the UK being affected by the tightening of the financial constraints related to the turmoil in the financial markets."

In January, when it last updated its forecasts, the IMF was expecting much stronger growth, of 2.4%, in 2009, but the longer the credit crunch has continued, the more threatened the UK economy has become.

Darling insisted that the downgrade was "not surprising" and that the economy was "extremely strong". But the IMF's gloomy prognosis is a blow to his credibility, as he prepares to fly to Washington tomorrow to discuss the turmoil with his fellow finance ministers from the G7 industrialised countries.

A Treasury spokesman said: "We set out our forecast for the UK economy in the budget, and we stand by that. The Treasury has an excellent forecasting record and we've outperformed the consensus of independent forecasters over the last 10 years."

But as the impact of the banks' funding problems has begun to ripple out through the economy over the past few weeks, with mortgage-lenders pulling hundreds of cut-price deals off the market, Darling has come under attack from Liberal Democrat Treasury spokesman Vince Cable, and even from usually loyal Labour backbenchers, for failing to take pre-emptive action against the risk of widespread repossessions.

Philip Hammond, shadow chief secretary to the Treasury, said: "This worrying report adds to the growing evidence that Gordon Brown's economic incompetence has left Britain badly prepared. Alistair Darling is totally out of his depth and out of touch with the concerns of millions of families. To support the housing market and help maintain consumer confidence, he should be cutting stamp duty for first time buyers, instead of increasing taxes on the low paid."

Such is the concern at the global level about the potential damage to the economy as banks tighten their belts, that a series of radical options are on the table at the G7 meeting, including measures to force banks to reveal the full scale of their losses; and even coordinated action to take the risky mortgage-backed assets at the heart of the banks' problems onto governments' balance sheets.

Sterling hit an all-time low against the euro today, with a euro worth more than 80p, as the markets became increasingly pessimistic about the economic outlook.

In the UK, the Bank of England is widely expected to cut interest rates to 5% tomorrow, in an attempt to offset some of the credit tightening imposed by the banks.