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Warning: Britain faces new recession

Economy set to relapse into dreaded 'double-dip' downturn, say world's central bankers

The world's central bankers have warned that the British economy faces relapsing into another recession – the much-feared "double dip" downturn.

A continuing drought in bank lending, evidenced in the latest figures from the Bank of England, and the threat that spiralling public borrowing will feed through to higher interest rates and inflation, are judged by international economists to be mortal dangers to a sustained recovery.

The Organisation for Economic Cooperation and Development (OECD), which comprises the 30 most advanced economies in the world, added to the gloom, saying that Britain remained "deep" in recession and faced a "bleak short-term outlook".

"The recovery is likely to be slow and unemployment is expected to climb significantly," it said, adding that the Treasury could do "considerably more" to fix the public finances.

Both warnings are at odds with recent market optimism and so-called green shoots suggesting that output in the economy may be recovering. But the Bank for International Settlements (BIS), which includes the Bank of England, the US Federal Reserve and the European Central Bank, said it feared that the problems of the world's banks are far from fixed and could easily trigger a so-called "double dip" or "W-shaped" downturn. "A major cause for concern is the limited progress in addressing the underlying problems in the financial sector," it said.

"A significant risk is therefore that the current stimulus will lead only to a temporary pick-up in growth, followed by protracted stagnation."

The BIS cautioned that "governments may not have acted quickly enough to remove problem assets from the balance sheets of key banks". It added that financial products should be treated like medicines and sold to consumers only when they are certified safe, to help prevent a repeat of last year's financial meltdown.

Figures from the Bank of England yesterday confirmed that the banks and building societies remain reluctant to lend to any but the most secure of businesses and home buyers. Mortgage approvals barely improved during May, remaining stuck at a little over 43,000 – some way above the nadir of 27,000 last winter, but under half of their normal level. Analysts at Capital Economics said the figures were "consistent with house prices falling at double-digit annual rates".

Detailed data on changes to the money supply indicated that relatively little of the £100bn pumped into the economy by the Bank of England through its policy of "quantitative easing", akin to "printing money", is finding its way as yet into meaningful lending by the banks to small businesses and first-time buyers.

A small improvement in consumer confidence was registered last month, and there is plenty of evidence of more buyer interest at estate agents and of shoppers continuing to shop. However, for as long as the banking system remains reliant on public funding and unwilling to offer credit, little of this still-fragile optimism will be seen in hard purchases of "big ticket" items such as houses, cars and other goods linked to house purchase, such as electrical appliances and furniture.

Figures to be released by the Office for National Statistics are likely to reveal that the downturn in the UK in the first quarter of the year was even more severe than first thought, though most economists think the worst of the slump is over. A CBI survey published yesterday said more than 95 per cent of banks and building societies expected their bad debts to rise over the next few months. Such write-offs will join the existing "toxic assets" on the banks' balance sheets and make them even less willing to take on riskier lending – the much feared "negative feedback loop".

Most embarrassing for ministers is the OECD's "health check" on important public services. The OECD agreed that, since Labour came to power in 1997, health spending has "surged" but "the returns so far appear modest". Ironically, given official enthusiasm for "league tables", the OECD says the UK's economic future is endangered by the inequality of educational achievement – a factor which has left the UK towards the bottom of the league table of advanced economies for social mobility: "International standardised tests show that the UK lags better performing countries significantly."

However, the OECD supports the shift away from targeting: "The focus on raising the school leaving age and meeting performance targets in education may still be distracting attention from the more important goal of raising core literacy and numeracy achievement." It adds: "Adequate provision of public infrastructure should be a priority, particularly in transport where road and airport congestion, and problems in the rail system impede business and constrain productivity."

Ministers have cancelled this year's Comprehensive Spending Review on the grounds that the economic picture is too uncertain and that, after a general election, "tough choices" may become easier to implement. Still, the OECD said it wanted "explicit" detail on spending cuts and tax rises, adding: "Experience in other countries suggests that a focus on expenditure cuts, rather than revenue raising, is associated with more successful consolidations." At the moment, the OECD claims, the Government is not being "ambitious" enough.