Are you sure?

UK: Darling to forecast worst downturn since WW2

  Chancellor Alistair Darling will be forced to take an axe to his economic forecasts next week and admit the economy looks set for its deepest downturn since World War Two.

Since taking charge of the nation’s purse strings two years ago, Darling has got used to being the bearer of bad news. Britain’s banking sector was one of the first casualties of the global credit crunch and the economy has plunged into its first recession in almost 20 years.

In his pre-Budget update last November, Darling forecast the economy would contract by around 1% this year, a far cry from the 2% growth he initially envisaged. Despite a raft of stimulus measures, even this looks unrealistic and Darling is likely to admit the downturn will be three times sharper.

“Darling will have to downgrade his forecasts in a colossal way,” said Brian Hilliard, an economist at Societe Generale. “My guess is he’ll move closer to consensus and go for a fall of around 3% this year.”

Even a 3% decline would be relatively optimistic. The OECD has forecast a decline of 3.7% this year while the International Monetary Fund reckons Britain will be among the hardest hit industrialized countries and shrink by 3.8%.

The consensus of more than 40 economists polled by Reuters last week is for a contraction this year of 3.6%. That would surpass the 2.1% decline in 1980 as the biggest yearly fall since 1945.

UNCERTAIN FUTURE

Darling’s growth forecasts for future years may be watched even more closely. The government’s arithmetic for tax revenues and spending hinges on its outlook for growth, so any downward revisions would make its deficit forecasts even more alarming. The budget deficit already looks like rising to its highest proportion of GDP in peace-time history. Further deterioration could fuel concerns about the country’s ability to service its debt, sparking a renewed sell-off in the pound.

Opposition politicians have aired the possibility that the government may need to go cap in hand to the IMF, just as it did under a previous Labor administration in 1976.

Markets are not attaching much weight to such a scenario -- Britain’s debt-to-GDP ratio remains relatively low and appetite for government bonds strong. But Darling will be mindful of the dangers of generating negative headlines.

With an election due by mid-2010, Darling may have another reason to play up recovery prospects. Over-optimistic forecasts for this year could result in yet more embarrassing downward revisions, just before going to the polls. But ambitious forecasts further out carry little risk.

Last November, Darling forecast the economy would grow by between 1.5 to 2.0% in 2010 and 3% in the three subsequent years.

Economists are skeptical. History suggests recession-hit economies take a long time to recover and the need to reverse the recent fiscal stimulus with tax rises and spending cuts could create significant headwinds.

“A V-shaped recovery is out of the question,” said Marc Ostwald, a strategist at Monument Securities. “It could take five years or more for output to get back to pre-credit crisis levels.” (Reuters)