The Economy: In this uncertainty, recession is a possibility

No recession, but it will be quite a deceleration. As recently as last month, the Office for National Statistics pushed its estimate for current annual growth in the economy to 3.1 per cent, historically very respectable and some way above the economy's long-term trend rate growth of 2.75 per cent. According to the Chancellor's statement, GDP growth in the first half of the year reached 3.25 per cent on 2006, towards the upper end of the 2007 Budget's forecast range.

It is, as ministers repeat, much higher than most other advanced economies. Given that degree of momentum, and that the credit crunch came fairly late in the year, with a lag on when it will feed through to the "real economy", the Treasury feels confident its 3 per cent growth forecast for this year is in the bag. However, as they say in the City, that was mostly "BC", "Before Crunch".

The extent to which the economy will be hit by the slowdown in the US is demonstrated by the reduction in the growth forecast for next year. Lopping half a percentage point off the figure in reality means that the UK will be £7bn, or about £300 per household. The squeeze on disposable incomes – mainly due to the unaffordabilty of housing, with the savings ratio recently at a 40-year low, taxes increasing, and mortgages rising with five rises in the Bank of England's base rate – may become even more painful.

Sooner or later the decline in economic growth will be reflected in lower wages settlements. These are depressed – about 3.5 to 4 per cent, leaving little real increase – and reflect a weakened labour market. The problem would really be if unemployment and the fear of it started to tick upwards. Headlines about depressed spending at Christmas and house prices going backwards are the last thing the economy needs. The OECD says the UK will have the largest (structural) government deficit out of the main EU economies, proving little space for emergency action if the economy starts to behave badly.

The question is whether the Government's optimistic belief that growth will return to its 2.5 per cent to 3 per cent range in 2009, and thus keep the budget balanced over the cycle, is remotely realistic. Generally, the City is sceptical. Barclays Capital pointed out: "Given what we view as overly-optimistic medium-term projections for the budget surplus, and a question mark over the dating of economic cycles if growth drops below trend next year, we are doubtful the golden rule can be met."

Michael Saunders, of Citi European Economics, said: "The Government is in pre-election mode, and this medium-term spending squeeze is not politically sustainable in the election run-up, whether it is held in 2008, 2009 or 2010. These plans would require the Government to do things more efficiently. But the Government has not implemented this stepping stone to fiscal prudence. Public sector productivity growth has been weak. Moreover, on average since 2000, the deflator for government consumption has risen three times faster than the CPI.

"The Labour conference speeches by Brown and Darling showed vaulting ambition for ... expanded state-financed services. After the Conservatives' successful conference, genuine pre-election tax cuts will be a political necessity."

It cannot have been easy for the Chancellor to frame this pre-Budget report and Comprehensive Spending Review, coming as they do a mere few weeks after the worst crisis in the credit markets for decades, the run on Northern Rock, and with the US investment banks reporting large losses as a result of the sub prime crisis.

The outlook is unclear, with a degree of dissent among economists about how bad 2008 is going to be. None are talking about a recession in the UK, but a few echo the sorts of noises Alan Greenspan, former chair of the US Fed, about the possibility of the R-word striking the American economy – somewhere between a third and a half. Could it happen here?