Britain faces a toxic combination of a deep and prolonged recession, deflation and soaring unemployment this year and next, the CBI warns today.

It says that the country's economic output will fall by 3.3 per cent this year - the sharpest annual contraction since the Second World War - and will all but stagnate in 2010. The recession will force companies to axe hundreds of thousands more jobs and unemployment will top three million next year.

The CBI Director-General attacked the Government for failing to head off the worst of the downturn. Richard Lambert criticised the attempt to stimulate consumer spending by cutting VAT from 17.5 per cent to 15 per cent. He said: “Was a VAT cut the best way to spend £12billion in the face of the onset of the most severe recession in decades? No.”

Mr Lambert said that the Government needed to draw up a timetable to outline when its multibillion-pound package of measures, announced last month, would come into force. “Business needs the Government to hurry up,” he added.

The CBI said that consumer spending would plummet by 2.7 per cent this year, reversing the 1.7 per cent rise last year, as workers, worried about falling house prices and deteriorating employment prospects, conserved their cash.

Businesses grappling with the slump in demand and difficulties in securing funding from banks were taking drastic action to cut costs, the CBI said. As a result, unemployment was likely to climb by more than a million to peak at 3.04million between April and June next year - the highest since 1986. The CBI said that dole queues would nearly double to 2.36million by the end of 2010.

Unemployment levels reached nearly two million between October and December, official figures show. The sharp deterioration in the global economy will compound Britain's problems because businesses cannot rely on trade with other countries.

The CBI said that GDP would drop by between 1 and 1.5 per cent in the first three months of this year and fall by a further 0.75 per cent in the next quarter. Although the CBI said that the pace of decline would ease later this year, it predicted there would be no quarterly growth until April next year. Even then, the recovery will be so shallow that GDP will stagnate at 0 per cent on an annual basis.

Despite the dismal figures, the CBI said that the peak-to-trough drop in GDP would still be more modest than that of the recession of the 1980s.

The CBI's outlook is even more gloomy than that of the International Monetary Fund (IMF), which said last month that Britain would be harder hit than any other advanced nation, shrinking by 2.8 per cent this year.

The Government estimates that GDP will drop by between 0.75 per cent and 1.25 per cent this year.

A separate survey out today shows that 39 per cent of British manufacturers are finding it more difficult to get finance now than they did three months ago. The Markit Credit Conditions survey shows that one in six factories said that this holds them back.

In a further blow for savers, the CBI said it expected interest rates to remain low as the Bank of England battled falling inflation. But it said that consumer prices would continue to drop, pushing the country into deflation for several months this year and keeping inflation at well below the Bank of England's 2 per cent target until 2011. Pay or pensions linked to the alternative RPI measure of inflation could suffer from a dip in the rate as low as minus 4.4 per cent this year, the CBI said.

Government finances will also be hit hard as tax revenue falls. The CBI expects that the Treasury's tax receipts will have slid by £60billion by 2010, while its borrowing will nearly double this year to £148 billion and rise to nearly £170 billion next year.

Only one part of the Government's stimulus package, including a scheme to guarantee banks' toxic loans to help them to lend, has started. The Bank of England began pumping up to £50billion into British companies in return for short-term IOUs on Friday.

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