Darling predicts short sharp shock

Alistair Darling will forecast a short, sharp recession in his crucial pre-Budget report in 11 days' time, with the economy contracting by more than 1 per cent next year but bouncing back strongly in 2010.

In an exclusive interview, the Chancellor told The Independent yesterday: "We are going into recession. I remain confident that we will get through it." It was his clearest admission yet that a recession is inevitable.

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Mr Darling was speaking on a day when unemployment rose to 1.82 million, its highest level for 11 years. He said the Government needed to get "sharper and smarter" about getting people into new jobs.

In his Commons statement on 24 November, he is expected to reveal a dramatic increase in public borrowing, up from the £43bn for the current financial year he predicted in his March Budget to around £65bn. Next year, as the recession bites, it is likely to rocket to more than £90bn.

Mervyn King, the Governor of the Bank of England, added to the growing gloom by warning yesterday that the economy will shrink by as much as 2 per cent by early next year.

The Treasury is still finalising its growth forecasts but they will be in line with those issued by the Bank yesterday. That points to a contraction of about 1.3 per cent in 2009 but recovering quickly to grow by about 1.7 per cent in 2010 – the likely general election year – and by 3 per cent in 2011.

The Chancellor will blame falling government revenues for the rise in borrowing. Corporation tax from business, due to raise £51.9bn in the current year, will bring in about £15bn less than forecast. Stamp duty from property and share transactions, due to raise £13.5bn, is likely to bring in only about half that amount.

Mr Darling will use some of the soaring borrowing to cut taxes in order to keep the economy moving – but he raised the prospect of tax rises in the medium term.

In his interview, he defended his plan for a "fiscal stimulus" but made it clear he was ready to raise taxes in future years to bring borrowing back under control. He promised that his pre-Budget report would spell out how that would be achieved.

"It is right to let borrowing rise," he said. "It is also important that we come back into balance over the medium term. The basic principle is to support the economy now but you have got to make sure you live within your means."

He denied that his statement would confirm that Labour's relationship with "Prudence" was over. "Far from it," he insisted. "It is prudent that you support the economy in the difficult times. It is prudent if you get long-term sustainability. What is imprudent is if you have a set of rules which you then apply regardless of what is going on around you and the consequences. That is when you get into real difficulties."

The Chancellor also defended plans to relax Gordon Brown's much-trumpeted fiscal rules, which say that public sector debt should not exceed 40 per cent of national income. "To apply them willy-nilly without any regard to what they actually mean would be daft," he said, adding that it would be "utter madness" to start taking money out of the economy now.

Ministers have been reluctant to use the "R-word" – although Mr Brown broke the ice last month by warning that Britain could not be immune from a "global recession". The Treasury will not formally confirm a recession has begun until early next year, when figures for the final three months of this year confirm two successive quarters of negative growth.

Some 140,000 people joined the ranks of the unemployed in the three months to September. Experts believe the number will pass the two million mark by Christmas and could even rise as high as three million. Presenting his quarterly report, Mr King said: "[It is] very difficult to know precisely how long we'll be in recession. I think we probably are in recession now."

He raised the prospect that the Bank might cut interest rates to an unprecedented zero to protect the economy. They would be reduced to "whatever level is necessary" to stave off a long and deep recession. Rates have never fallen below 2 per cent, but the Bank now believes inflation could drop to just 1 per cent next year.

However, Mr King forecast a swift recovery. "We are moving into very difficult times and people should be concerned we are moving into those difficult times, but that is not to say we won't come through it. We will come through it and we are taking the right actions to come through it." Mr King gave his backing to the proposed "fiscal stimulus" – provided it was temporary and action was taken to bring tax and spending back into a "suitable balance" in the medium term.

Jonathan Loynes, chief European economist at Capital Economics, said a further cut in base rates of half a percentage point now looked very likely next month, with rates dropping further to 1 per cent by the middle of next year. "We would not rule out the possibility that interest rates fall all the way to zero," he said.

Graeme Leach, chief economist at the Institute of Directors, said: "For the next 12 to 18 months, the only way for unemployment is up. We think it will reach 2.5 million by this time next year, peaking at around 2.8 million in 2010."