Markets dive as depression fears grow

Bank of England warns of 'choppy recovery' as it cuts growth outlook amid slew of gloomy data, Economics Theory.

Fears that Britain could slip into a protracted depression intensified tonight as markets took fright at the US central bank's wary economic outlook, the Bank of England's own warnings on the UK, and a slew of gloomy data.

With businesses and households fretting over swingeing public sector spending cuts and shaky economic prospects around the world, the Bank cut its growth outlook and warned that Britain faces a long and "choppy recovery".

The move came as official figures showed a sharp rise in long-term unemployment and a smaller than expected fall in the number of people claiming jobless benefits.

The Bank's outlook intensified the debate over whether the economy is heading for a double-dip recession, or at least a period of depression. The National Institute of Economic and Social Research thinktank defines depression as a period when output is below its previous peak, and has predicted that in the UK's case this will last until 2012.

Faced with calls from trade unions to scale back its cuts or risk seeing growth peter out, David Cameron's coalition at least got some support for its austerity measures from the Bank's governor, Mervyn King, who reiterated that a fiscal squeeze now would reduce longer-term risks to the economy.

But the Bank also cited the cuts as at least part of the reason why it was more cautious on growth. Also blaming tight credit conditions and increasingly fragile confidence among consumers and companies, its quarterly inflation report, which forecasts economic prospects two years ahead, sees growth nearer 3% then, down from its previous prediction for about 3.5%.

The softer outlook and the Bank's view that inflation will finally fall back in 2012 left financial markets scrambling to reassess the outlook for interest rates. The cost of borrowing for the government on a five-year bond fell to its lowest level in almost 20 years, as traders raised their bets that interest rates will remain at their record lows for many months to come. The FTSE 100 suffered its biggest drop in six weeks.

But many economists said the Bank was still too optimistic about growth. Even the government's own fiscal watchdog is less upbeat and the market consensus is closer to 2% growth for two years from now.

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