Risk that flu outbreak could tip 'stretched' UK into deflation

Swine flu could tip the UK into deflation and see gross domestic product (GDP) plummet by 5 per cent as panicked consumers stay at home to avoid infection, a report said today.

As workers fall ill and take time off work businesses will struggle to maintain productivity, and those who escape infection will find it difficult to get to the office as staff shortages hit the transport network, the report by economic forecaster Oxford Economics said.

The firm has based its forecast on the effect of the Sars outbreak in 2003 on the Asian economy, which hit leisure spending and caused a collapse in travel to affected countries.

But it warned that the current recession will mean that the UK economy will not bounce back as the Asian markets did and it could take up to four years to recover.

The report states: "This time around, such a sharp rebound is unlikely. GDP would likely remain below baseline for some time. However, by 2011 GDP growth could be above our baseline forecast and the economic loss would be gradually recouped within around 3-4 years.

"But there is a risk that swine flu tips the UK and the world economy into deflation. This is because the pandemic would hit at a time when businesses and banks are still reeling from the economic crisis.

"The fact that UK households' balance sheets are more stretched than in many other countries makes the risk of deflationary dynamics larger than elsewhere. In addition, companies that are already fragile after the recession may succumb to this new shock."

The report also found predictions that a possible pandemic could happen around Christmas could further dent the economy and the UK is most at risk from the economic impact of a pandemic because if its already stretched balance sheet.

It found: "A flu outbreak in the autumn would hit just as the economy starts to recover from the credit crunch.

"It would threaten already fragile businesses and put further strains on financial markets and fiscal balances. This could generate a vicious cycle that postpones the recovery for another couple of years.

"The fact that UK households' balance sheets are more stretched than in many other countries makes the risk of deflationary dynamics larger than elsewhere."