Monday, the Ernst & Young ITEM Club said the UK output would stabilize by the end of this year, with a modest recovery beginning next spring. The think tank expects the British economy to shrink 3.5% in 2009 and 0.1% next year.

In its Spring forecast report, the ITEM Club identified signs of stabilizing financial situation and credit conditions. The group said that in response to the huge resources, which the government has thrown at the economic problems, confidence is starting to improve.

Inflation is forecast to fall back sharply over the coming few months and the risk remain that the recession will push inflation into negative territory and hold it there. To contain this risk, the ITEM Club said interest rates must be kept at or near their present level until the 'green shoots' really do appear. Then, the thrust of monetary policy will have to be reversed sharply.

Output and interest rates would possibly rise sooner in the UK than in other western economies, the report said. Consequently, company treasurers would prefer to take advantage of funding window opened up by the new quantitative easing policy, it added.

According to the ITEM Club, the current recession is unusual in terms of the degree of monetary and financial stimulus compared to the previous one. The group pointed out that in the previous recessionary period, monetary policy had to be tightened to combat rising inflation.

The ITEM Club is of the view that companies continue to cut spending with business investment forecast to drop around 8% in 2009 and another 2.5% next year. Accordingly, government capital spending would not be enough to offset the weakness in corporate investment and total investment will drop about 10% in 2009.

Employment levels also continue to fall. The forecast suggests that 900,000 jobs will be lost this year, and another 500,000 in 2010.

Earnings growth is slowing and is likely to fall further on sustained labor market weakness. This is expected to maintain downward pressure on disposable income. Consumer spending is expected to decrease 3.1% this year and a further 0.7% in 2010.

The decline in the pound provided huge opportunities for businesses and a weaker pound put UK exporters in prime position to take advantage of the world market, the ITEM Club said. World trade is forecast to drop 9% this year, while UK exports are expected to fall back by 9.7%.

The ITEM Club said prospects for a recovery in the UK housing market will remain in doubt until the Crosby proposals for supporting mortgage finance are implemented.

Elsewhere, the Confederation of British Industry forecast a slow and fragile recovery in the UK with growth resuming only in the spring of 2010. The industry lobby said the recession deepened more than expected in the first quarter of this year, but it is forecast to moderate in the second half of the year.

The CBI revised down its GDP forecast for 2009 to a 3.9% contraction compared to an earlier estimate of a 3.3% GDP decline, reflecting a harsher sequential decline of 1.8% in the first quarter of 2009.

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