Darling wrong on recovery, Gieve warns

The economic forecasts made by the Chancellor in his pre-Budget report two months ago were over-optimistic, Sir John Gieve, deputy governor of the Bank of England, warned yesterday.

Sir John said that hopes that the economic recovery would begin in the third quarter of this year – as forecast by Alistair Darling in the PBR, and the Bank of England itself – were likely to be dashed.

"The immediate prospects in the UK, as elsewhere, remain difficult," Sir John said. "Data on new orders suggest that output is likely to fall sharply in the first quarter of 2009, as well as in the fourth quarter of last year; further declines in output, if not at the same pace, are likely beyond then."

If the UK were to experience more than one quarter of negative growth after the first quarter of this year, Mr Darling's prediction of a recovery in the third quarter would be confounded. While Treasury officials now privately admit that the Chancellor is likely to have to revise his economic forecasts downwards in the next Budget, in March or April, the fact that the Bank of England's deputy governor is already warning that Mr Darling's predictions will not prove correct underlines the speed with which the downturn has taken hold in the UK.

Some independent economists are even more gloomy. One widely respected body will warn this weekend that it now expects negative growth in every quarter of this year, with the recession continuing into 2010.

The size of the downturn that has already occurred will become clear when the Government publishes its economic growth figures for the fourth quarter of the year. A negative figure for a second successive quarter is now a foregone conclusion, but analysts believe the decline is likely to be in excess of 1 per cent, compared with 0.5 per cent in the third quarter of 2008.

Sir John said the UK was set for its most serious recession for some time. "We expect the sharpest fall in output for decades, while on some measures retail prices are likely to fall for the first time in almost half a century," he said. "A decade or more of remarkable macroeconomic stability, the Great Stability as economists called it, has come to a shuddering halt."

Economists said Sir John's comments were a clear signal that the Bank of England would cut interest rates further, having already taken the base rate to 1.5 per cent, the lowest level in history.

"They reinforce our belief that the Bank of England will cut interest rates by a further 50 basis points to 1 per cent in February," said Howard Archer, chief UK and European economist at Global Insight.

"Further out, we see interest rates coming down to a low of 0.25 to 0.50 per cent in the second quarter. Indeed, it is very possible that they could come all the way down to zero. In addition, it seems likely that the Bank of England will eventually engage in some form of quantitative easing, in tandem with the Treasury."

Sir John said yesterday that while problems remained with the way in which interest rate cuts were being passed on by lenders, the reductions were helping. "The cuts in interest rates are having an impact," he said.

However, the deputy governor echoed remarks made this week by Ben Bernanke, the chairman of the US Federal Reserve, who warned that a wide package of measures would be needed to arrest the global downturn.

Like Mr Bernanke, Sir John said that, in addition to fiscal and monetary policy responses, authorities around the world would have to focus on how to improve the flow of credit in the banking market.

"Long experience has shown that interest rates are the most powerful and effective instrument for managing the economy," Sir John said. "However, the distinguishing feature of this recession is that it is centred on the banking system ... it is no surprise therefore that both in this country and elsewhere interest rates have been supplemented by measures that have directly focused on banking and financial markets."