IMF predicts UK recession and house price falls up to 30%

World economy 'is now entering a major downturn'

The International Monetary Fund (IMF) became the latest body to predict a recession in the UK, when it radically downgraded its forecasts for British economic growth yesterday, and declared house prices 20 to 30 per cent overvalued.

The IMF's biannual World Economic Outlook report said that "the world economy is now entering a major downturn in the face of the most dangerous shock in mature financial markets since the 1930s... The major advanced economies are already in or close to recession".

The credit crunch is spreading beyond the banks, it said: "Such strains could well foreshadow a more severe impact".

The UK will see growth at 1 per cent in 2008, says the IMF, and will shrink by 0.l per cent in 2009, these forecasts being 0.8 and 1.8 percentage points lower than the IMF's most recent update, issued as recently in July.

The IMF joins the OECD, the European Commission, the Bank of England and a score of City economists in anticipating a year of stagnation or worse: 2009 would be the first year of recession seen in the UK since 1991. The US will see growth at 1.6 per cent and 0.1 per cent, and the EU 1.7 and 0.6 per cent respectively over the next two years. A recession in North America is "now looking increasingly likely".

On an annual basis, global growth is expected to moderate from 5.0 per cent in 2007 to 3.9 per cent in 2008 and 3 per cent in 2009, on the edge of the IMF's definition of "global recession".

The IMF cautions that the recent financial turmoil is likely to depress economic prospects, with a "cascading series of bankruptcies, forced mergers and public interventions in s and western Europe". It adds: "Recovery later in 2009 will be exceptionally gradual by past standards."

Endorsing the Treasury's plans to buy equity in British banks, the IMF said: "Public funds are likely to be needed to help banks rebuild their capital bases."

The Fund implicitly approved of the Bank of England's move, co-ordinated with other central banks, in reducing interest rates by 0.5 per cent: "Moderating inflation pressure and the deteriorating economic outlook already provide some scope for monetary easing in some cases, notably the euro area and the UK."

However, there was a hint at criticism for the way that Gordon Brown has run the public finances: "The Achilles' heel of an active fiscal policy remains political economy settings that foster shorter term decision-making. As a result many countries fail during good times to build room for effective discretionary stimulus during downturns."

Chillingly for the UK's housing sector, the IMF said that house prices in 2007 appeared to be 20 to 30 per cent overvalued, when taking into account economic fundamentals. Its economists suggest that the subsequent correction will take place "over several years".

The IMF's chief economist, Olivier Blanchard, said: "With the right macro and financial policies – and these policies are available – we can ride the storm, and expect a recovery to start in the course of 2009."