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In the latest issue of the Deloitte Economic Review (PDF, 1311KB), our Economic Adviser, Roger Bootle warns that although an outright meltdown of the financial system appears to have been avoided, the full economic impact of the credit crisis has yet to be felt. He believes that the current economic downturn will rival that seen during the early 1990s. His main points are as follows:

• Recently announced measures by the UK Government and other world policymakers have avoided the unthinkable scenario of a full-scale meltdown in the UK and global banking and financial systems.
• But they are unlikely to prevent a major slowdown in the rate of bank lending to households and companies from contributing to a significant contraction in economic activity over the next several years.
• A combination of falling house prices, sluggish income growth and high inflation has already prompted a sharp slowdown in consumer spending growth, while business investment has also slumped.
• These developments have started to take their toll on the labour market. We now expect unemployment to rise by 1.5 million on its widest measure over the next two years, compounding the downward pressure on house prices and consumer spending.
• Against this background, concerns over inflation will continue to fade rapidly. Having peaked at around 5%, consumer price inflation will plummet to around 1% by the autumn of 2009 and could even turn negative if oil and food prices fall much further.
• Faced with such a prospect, the MPC will slash interest rates very aggressively. We now expect rates to fall to 2.5% next year, their lowest level since 1951 and they could easily fall beneath their previous all-time low of 2%.
• But that won’t stop the economy from contracting sharply over the next two years. We now expect GDP to fall by a full 1% in 2009 and by another 0.5% in 2010. This would put the current downturn in the same league as that of the early 1990s, when output fell by 2.5%.
• And things could be even worse if a more vicious circle between events in the real economy and the financial markets develops. In the worst case scenario, this could prompt a significant fall in the price level and a bout of Japanese style “debt-deflation”.
• Neither is any recovery likely to come quickly. History shows that the economic fallout from previous financial crises has often lasted for a number of years. The need for a major fiscal consolidation at some point is another threat.
• But we think that there are three reasons to be less than apocalyptic. First, the sharp fall in commodity prices will allow household real incomes to start growing again. Second, low interest rates will bolster demand. Third, once the world economy recovers, the fall in the pound will increase competitiveness and boost net exports.
• What’s more, the credit crisis may ultimately leave the financial sector in a much healthier and efficient state, thereby allowing it to contribute more strongly to the future progress of society at large.

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View other economic material from Roger Bootle, including his monthly economic updates.

This assessment contains general information only and is not intended to be comprehensive nor to provide professional advice.  It is not a substitute for such professional advice and should not be acted on or relied upon or used as a basis for any decision or action that may affect you or your business.  Deloitte & Touche LLP accepts no duty of care or liability for any loss occasioned to any person acting or refraining from acting as a result of any material in this assessment.