The world economy remains at serious risk of suffering deeper turmoil in financial markets that could trigger a severe global downturn, the International Monetary Fund (IMF) said yesterday, as it sharply cut forecast growth in key economies next year.

In a stark warning that the squeeze in lending markets worldwide could spiral into a full-scale credit crunch, the IMF said “financial market conditions remain a major source of down-side risks to the global outlook”.

The fund said its main forecast remained for only a moderate slowdown in 2008, with world growth still set to “remain at a buoyant pace”.

Global activity should be underpinned by a strong boost from China, which for the first time is set to make the largest contribution to world growth of any country.

But despite its relatively sanguine central forecast, Simon Johnson, the IMF’s chief economist, emphasised: “The world economy has entered an uncertain and potentially difficult period. The financial turmoil of August and September threatens to derail what has been an excellent half decade of growth.”

The IMF’s main forecast is for global growth to slow next year to a still “solid” 4.75 per cent from 5.2 per cent this year, substantially because of the US being unlikely to see any rebound in growth in 2008. However, the fund said it judged there is at least a one in six chance that global growth will tumble to 3.5 per cent or less in the coming year, which would mark the weakest performance since 2002.

Risks from the markets’ upheavals were at the top of the IMF’s list of threats. “There remains the distinct possibility that recent turbulent conditions could continue for some time and generate a deeper “credit crunch” than envisaged in the baseline scenario, with considerably greater macro-economic impact,” it said.

“The most likely outcome is a gradual return to more normal market conditions. Nevertheless, conditions in financial markets remain volatile and the stress in credit markets may continue despite efforts by central banks.”

Should market turmoil deepen, the fund said that this would spell tighter lending conditions for “even high-grade borrowers” among both households and companies. America would be hardest hit by the resulting toll on growth, but Europe was also likely to be severely affected.

On its main forecasts, the IMF projection for US growth next year of just 1.9 per cent, drastically down from the 2.8 per cent it predicted in April, is the same pace of expansion it now expects in the American economy this year.

Yesterday’s report said the US would be hit by an extended decline in its housing market.

Although US inflation figures for September showed that the headline rate jumped to a six-month high of 2.8 per cent, the IMF said pressures had “moderated”. It expects that to open the way for a further half-point cut in US interest rates in coming months.

In Europe, growth is also expected to brake sharply next year. The eurozone is likely to see an expansion of only 2.1 per cent next year, down from the 2.5 per cent the IMF forecast in April, and a likely 2.5 per cent this year. Britain is expected to grow by only 2.3 per cent in 2008 _ down from the 2.7 per cent the IMF expected in its April view, and compared with a boom-like 3.1 per cent likely this year.

The IMF said that if the downturn in Europe deepened, cuts in UK and eurozone interest rates “would need to be considered”. But it cautioned that if the worst risks it feared in markets did not materialise, rates on both sides of the Channel could still need to be raised. For now, the European Central Bank and Bank of England were right to keep rates on hold.

Explore Economics

• Pre-Budget Report 2008

• Budget 2009

• World Economic Forum

• The Times MPC

Times Recommends

• Lies and cover-up at MG Rover exposed by report
• High oil prices push manufacturing costs up
• Primark founder steps down as chief executive