Sean O'Grady: Forecasts still optimistic, despite the downturn

The Economy

In the biggest growth downgrade in the history of Treasury forecasting, Alistair Darling substituted his November forecast of a mild recession and a 1 per cent contraction in the economy this year into a "steep" fall of between 3.25 and 3.75 per cent – the worst since the Second World War.

That brings him closer into line with the bulk of independent forecasters, such as the International Monetary Fund, who see a 4.1 per cent drop in output in 2009.

But Mr Darling was still far more optimistic, and out-of-step with the consensus, when he declared that the economy would start to grow "towards the end of the year", leading to recovery and positive growth of about 1.25 per cent in 2010, and 3.5 per cent in 2011.

Inflation is also set to be low, a symptom of very weak demand in the economy, staying well below the official target of 2 per cent for most of this year and next. Even more disappointingly for the authorities, the balance of payments doesn't seem ready to contribute hugely to growth, despite the near-30 per cent depreciation in sterling since its peaks in 2007.

Economists and investors voiced an almost unanimous scepticism about Mr Darling's figures, and warned against the current fashion for spotting "green shoots". Edward Bonham Carter, the chief executive of Jupiter Asset Management, said: "We should be prepared for a few 'false dawns'. When a recovery does come, it is likely to be anaemic as consumers and government seek to clear the vast overhang of debts built up in recent years. If one were to visualise such an outlook, it would resemble more of a 'ladle-like' recovery than the V-shaped recoveries we have seen in the past."

The question for the economy may be not so much whether Mr Darling's polices will work, but whether the other arm of economic policy – monetary action – will do so.

The markets seem worried that the Bank of England's policy of "quantitative easing" will falter because of the vast quantity of gilts being issued – some £240bn next year. The relative weakness of sterling yesterday sent another signal about investors' waning appetite for UK government paper.

Long term, economists will be alarmed to see the 10 per cent fall in investment this year. Such a fall in building the productive capacity of the nation threatens to suppress the long-term trend rate of growth in the economy, making it harder to pay off our debts, fund rising living standards and afford better public services. It will leave future governments in an even tighter straitjacket and make Britain less able to take advantage of the doubling in the size of the world economy in the next 20 years that Mr Darling pointed to as the main engine of future growth.