Swine flu epidemic could derail Britain's recovery

Illness could cost the economy almost £50bn, say ITEM Club forecasters

A swine flu epidemic would cost the UK economy almost £50bn, according to one of the nation's most respected groups of economic forecasters, the Ernst & Young ITEM Club, which uses the Treasury's economic model to produce its forecasts.

Added to the expected shrinkage in the economy this year of 4.5 per cent, a worst-case scenario would see a total drop of 7.5 per cent in GDP – the most for at least 75 years – with another loss of national income to come in 2010.

The ITEM Club's forecast points to the H1N1 virus as a significant risk to recovery, especially as a pandemic would, be definition, affect all the major economies: "We estimate that UK GDP would fall by 3 per cent in 2009 and another 1.7 per cent in 2010 ... . With the Western world still teetering on the brink of deflation, it is not an exaggeration to say that a pandemic on this scale could tip it over the edge."

The economists say that swine flu would affect the economy in several ways: "Assuming that the death rate remains low, the main effect on the supply side will be that sick employees cannot go to work. On the demand side, spending on discretionary goods and services such as restaurants or tourism is likely to fall as people stay away from public places to avoid infection. Uncertainty about these developments is likely to make businesses further postpone investment projects."

Even without an epidemic, the outlook remains grim. Extending their medical theme, the forecasters say that the economy is like "a patient that has been stabilised but a relapse is still possible". They caution that "recent hopes of recovery are now running ahead of reality", and say that the economy will shrink by 4.5 per cent this year, the worst since 1945. Should a swine flu epidemic simultaneously hit the economy, the drop in output might approach the worst years of the Great Depression. If the population stays relatively healthy, a "subdued" return to growth of 0.5 per cent is pencilled in for 2010.

Peter Spencer, chief economic adviser to the ITEM Club, said: "The economic patient has been in trauma, but thanks to the paramedics at the Treasury and the Bank of England who pumped billions of pounds-worth of medicine into the economy, the patient has been stabilised for now. But it remains unclear how quick and complete recovery will be, and there is still a serious chance of a relapse."

Referring to sterling's depreciation since its 2007 peak, Mr Spencer added: "Unfortunately it is hard to see any very solid grounds for sustained optimism at the moment. The only ray of hope is a potential recovery in world markets, which UK exporters can exploit because of the low level of the pound."

As with recent forecasts from the IMF and the OECD, the ITEM Club's pessimism about the strength of recovery stems from the weakness in the financial sector and the unwillingness of banks to resume lending on anything like the scale seen before the credit crunch.

The scale of public borrowing and the overhang of private and public debt also poses a medium-term challenge to recovery. "Capital remains short and expensive for the banks, and there is currently little sign of any extra lending to either companies or consumers. Banks are saying that they will expand lending more aggressively over the next three months, but it seems most unlikely they'll come close to meeting the demand for credit," says Mr Spencer.

However, he says that the flexibility of the labour market has meant that the rise in unemployment has not been as bad as was first feared. "Employers seem to have learnt from the recession in the 1990s that a slash-and-burn approach can turn out to be a handicap once the recovery begins." ITEM sees unemployment peaking at 2.8 million, rather less than some other observers.