Unemployment in Britain will surge by 450,000 to 2.12 million by the end of next year, a level not seen since 1997, when Labour came to power, as the country endures its first recession since the early 1990s, the CBI forecasts today.

In a dramatically revised outlook for the economy, the employers' organisation says that Britain is already in a recession and will not recover until the middle of next year. It adds that homeowners will continue to suffer brutal falls in the value of their property.

The CBI says that the dismal economic conditions will lead to hundreds of thousands of job cuts by the end of 2009, forcing the number out of work above two million and taking the rate of unemployment up from 5.4 per cent to 6.8 per cent.

Richard Lambert, Director-General of the CBI, said: “We are now almost certainly in a mild recessionary phase.”

Earlier this year the CBI said that Britain would avoid recession, but it has drastically cut its forecasts after continued surges in energy prices and an economic slowdown that has been far sharper than expected.

The Organisation for Economic Co-operation and Development and the European Commission have slashed their forecasts for the UK to show a recession in the second half of the year. The British Chambers of Commerce has said that the recession could lead to more than two million people unemployed by Christmas.

The CBI also forecasts that the Government will break one of its fiscal rules. It says that government borrowing is set to rise, pushing public net debt to more than 40 per cent of GDP.

The Government has often pledged that it would not breach this threshold over the economic cycle, but there is speculation that Alistair Darling is preparing to change this rule in his Pre-Budget Report next month to give the Treasury room over spending.

This comes days after Mervyn King gave warning that breaking the fiscal rules could lead to higher inflation. The Governor of the Bank of England said: “The long-term risk is [that] a fiscal framework that is not perceived by financial markets to be credible does put up pressure on inflation expectations, because it undermines the market's belief in the credibility of both the monetary and the fiscal framework.”

The economy ground to a halt between April and the end of June, recording no growth at all, official figures show. The CBI believes that that it is set to shrink by 0.2 per cent between July and and the end of this month and contract by a further 0.1 per cent in the final three months of the year. A recession is defined as two consecutive quarters of shrinking output. The CBI expects the economy to stall for a further three months at the beginning of next year, before growing marginally by 0.1 per cent between April and June.

Mr Lambert said that while he did not believe that conditions would be as bleak as in the early 1980s and early 1990s, consumers and businesses were in for a tough time.

There was more bad news for homeowners as the CBI said that the value of an average house would tumble by about £33,000 from January's peak of £221,130, based on house price figures from the Department of Communities and Local Government. Ian McCafferty, chief economic adviser to the CBI, said: “The existence of the credit crunch has made the adjustment in the housing market more brutal than it would otherwise have been.” He said that the mortgage market would remain clogged up until next summer, as mortgage funding remained scarce.