Britain's economy is set to shrink over the next year as a deepening recession inflicts the first full-year fall in national income since 1991, a leading forecasting group predicts today.

In a dire assessment that will fuel fears over the growing severity of the downturn gripping the nation, Capital Economics becomes the first significant forecaster to project that the slump will lead to a full-year drop in GDP over 2009.

Its prediction that national income will decline next year by about 0.2 per cent is far bleaker than the present average City view, which still foresees meagre growth next year of about 0.9 per cent. Capital's forecast comes after updated official figures last week revealed that growth ground to a halt in the second quarter for the first time since the end of the recession in the early 1990s.

The group's grim prognosis for Britain will come as another blow to Alistair Darling and Gordon Brown as they struggle with the rapidly deteriorating economic prospects.

The Chancellor is expected to bow to the inevitable in the autumn and downgrade drastically his present forecast that the economy will grow by at least 2.25 per cent next year.

Capital says that it was forced to cut its own assessment after the news that growth stalled in the second quarter, pointing to a new recession having probably begun in the present quarter. “Britain looks likely to be the first major economy to fall into recession,” it concludes.

The consultancy is also alarmed by signs that the credit crunch is set to wreak further serious damage through a prolonged lending drought. “There is a growing danger that the downturn will be exacerbated by a contraction in bank lending to households and companies,” it finds.

It says that with banks still struggling to raise fresh capital after heavy losses from the US sub-prime crisis and housing slump, they will be forced to further constrict lending, with serious adverse effects on the economy.

At the same time, Capital sounds a warning that hopes of stronger overseas trade taking up some of the slack in the economy look set to be dashed as the eurozone, the destination for half of Britain's exports, also slides into recession.

Although a fall in GDP of about 0.2 per cent next year would mark Britain's worst annual showing since 1991, this would also spell a much milder recession than then, when national income plunged by 1.4 per cent in a year. Falls in GDP in the first half of next year would be offset by some recovery in the second half, Capital suggests, although it cautions that the outcome could be still weaker.

While Capital forecasts that the scale of the downturn will quell inflation, opening the way for steep interest rate cuts next year, hopes of any early move by the Bank of England will be dealt another blow today by figures showing a build-up of pay pressures.

Incomes Data Services, the pay adviser, reports that almost half of new wage deals in the past three months were for 4 per cent or more, while a tenth were at 5 per cent or above. The Bank has issued repeated warnings that excessive pay increases will only curtail scope for rate cuts and risk deepening the downturn.

Anxiety over the threat to jobs from Britain's economic woes is also emphasised today as a YouGov poll for the Trades Union Congress (TUC) shows that more than 3.3 million workers say they are not confident that they will still be in their jobs in a year's time.

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