Brussels adds to gloom with recession warning

Shadows lengthened over the British economy on Wednesday after the European Commission revised its economic forecast, becoming the second international body to predict gross domestic product will contract in the second half of 2008.

Brussels is now forecasting that GDP growth will fall by 0.2 per cent in each of the third and fourth quarters of this year, an even sharper slowdown than that predicted by the Organisation for Economic Co-operation and Development last week. The OECD is predicting contraction at less than 0.1 per cent per quarter.

The Commission is also forecasting two consecutive quarters of shrinking GDP for Germany and Spain this year. But in explaining why it now believes the UK faces a recession – officially, two consecutive quarters of contraction – it pointed to slumping domestic demand; in each of the first two quarters of 2008, this drop reduced growth by 0.3 per cent. Consumer spending, while robust earlier this year, slipped in the second quarter and fixed investment contracted markedly in both quarters.

The growing perception that the UK is struggling more than many eurozone nations, given its greater exposure to weakness in equity and credit markets, is undermining sterling. Since July 2007 the pound has fallen by 15 per cent on a trade-weighted basis.

Meanwhile, UK trade data on Wednesday showed that although export volumes had benefited from the weaker pound, they also threaten to fuel inflation further. Michael Saunders, economist at Citi, noted that excluding oil and other volatile goods, import prices in July rose by 9.4 per cent year on year, the highest growth rate since 1993.

The Commission said private consumption was likely to fall further in the second half of 2008, as consumers felt the pinch of tighter credit conditions, weaker housing and labour markets and stagnating real wages.

Overall, the Commission cut its UK growth forecast for the entire year to 1.1 per cent, much less than half that of the year before. The outlook for other European economies is little better.

The steep downward revisions in growth forecasts by the European Union’s executive arm showed it accepted that tumbling business and consumer confidence was hitting economic activity – even though the European economy had been “generally sound” prior to the outbreak of financial turmoil.

Joaquin Almunia, EU economics and monetary affairs commissioner, described the environment as “difficult and uncertain”. Significant housing market corrections in some countries were taking their toll, in addition to other factors, he said.

The Commission expected the 27-country EU economy to expand by just 1.4 per cent this year, and the 15-country eurozone by 1.3 per cent. That compared with the 2 per cent and 1.7 per cent it expected in its last forecasts in April.