BRITAIN is facing an “economic horror movie” because of a “toxic mixture” of a moribund credit market and volatile oil prices, according to a leading forecasting group.

The Ernst & Young Item club, which uses the Treasury’s economic model, will argue in a report tomorrow that the economy will struggle to avoid recession. This comes as a survey by the Institute of Directors shows that business confidence has slumped to the lowest level ever recorded, with company chiefs increasingly gloomy about the investment climate.

These reports follow an interview with Alistair Darling in which the chancellor admitted the downturn would be more “profound” and last longer than he had expected.

Also, Sir Win Bischoff, chairman of Citigroup, the American financial giant, believes that house prices in Britain and America will keep falling for another two years.

The Ernst & Young Item club predicts growth of only 1.5% this year, slowing to 1% in 2009. It says consumer spending will slow to a standstill, rising by only 0.2%, and forecasts a two-year drop in investment.

It also warns that the chancellor’s budget strategy has been thrown into “turmoil” by the downturn and an unplanned £2.7 billion tax giveaway. It predicts the budget deficit will top £50 billion and the “current” budget deficit, used to determine the golden rule, will remain in the red for at least the next three years.

Peter Spencer, chief economist at the Item club, said: “Both on the high street and in the housing market it is going to get a great deal worse before it gets better. We have already seen a housing crisis that has morphed from a credit crunch to a general collapse in confidence as prices have tumbled.

“Our worry is that without the usual medication from the Bank of England - which would have nasty inflationary side-effects in this environment - consumers will follow suit, moving from their current state of denial into a state of despair.”

Meanwhile, the Institute of Directors’ quarterly business opinion survey shows business optimism at its lowest level since the survey began in 1996. The proportion of company directors “more versus less” optimistic about their company’s prospects fell to -25%, compared with -17% three months ago.

Two-thirds of bosses think their own business is still performing well, though this was down on 74% last time.

Graeme Leach, chief economist at the institute, said that while the fall in business confidence was worrying, the survey’s results were mixed.

“Company directors seem to be saying we are doing okay at present but ask us again in three to six months and it could be hell out there,” he said.

“There are real difficulties in interpreting business confidence at the moment because there is a record gap between actual performance and future perceptions.”

Among the more optimistic signs in the survey, a net 12% of firms plan to increase employment and a balance of 8% think profits will go up. Asked about their investment plans rather than the general climate, a net 11% planned a rise. There was also a small rise in pricing intentions, with a balance of 15% of firms intending rises, against 12% three months ago.

“The sharp fall in overall business optimism is very worrying and points towards a recession,” said Leach. “Other results in the survey suggest we can still escape with a sharp slowdown over 2008-9. The survey suggests the pressure on the corporate sector for a labour shake-out is muted. Whether this situation will hold is the key uncertainty.”

The credit crunch is forcing more businesses into difficulty, according to research by the insolvency specialist Begbies Traynor. It monitors the number of firms reporting “critical” problems - those facing winding-up petitions or more than £5,000 in county-court judgments against them. The figure ballooned in the second quarter to 4,258, nearly seven times more than in the same period last year. The figure is up 30% on the first quarter of this year, with retail, construction and IT firms hit hardest.

Mark Fry at Begbies said the figures reflected companies’ increased willingness to pursue money owed to them. “It shows the general increase in financial pressure. Anyone with a big exposure to property has been severely affected - it has gone into freefall,” he said.

The Federation of Small Businesses is tomorrow expected to say that large groups have extended payment terms to their suppliers in an effort to ease their financial difficulties.

One company likely to be singled out is Alliance Boots, which changed its payment terms at the start of the year. It now takes 75 days to settle invoices, and applies a 2.5% settlement fee. The move has infuriated suppliers.

Justine Thompson, director of MTA International, which supplies staff-training packages, said: “It says on the Boots website that they are committed to treating their suppliers ethically and fairly, but these bully-boy tactics amount to a kind of theft. I think it’s absolutely outrageous.”

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