Top forecasters say that UK economy has “deteriorated dramatically” in the past three months, and feel the country is already in a recession.

The Ernst & Young Item Club believe the UK economy will shrink by 1 percent next year, before recovering in 2010 and growing by 1 percent. The Item Club’s chief economist Peter Spencer said, “Recession is already baked in the cake”.

However, on “bright spot” is that inflation looks likely to fall, allowing the UK to cut interest rates further.

The group said that company profits had been damaged already by very high commodity prices, warning that while the government‘s recent actions to ‘shore up’ the banking system are positive, the credit crunch will hit the economy “very hard”.

Mr Spencer said: “Even if equity markets stabilise and we begin to see capital flowing around the international financial system again, we are still looking at a domestic and global economy that will be in recession for the next 12 months.”

However, the Item Club forecasts that with dropping interest rates, falling inflation and a fundamentally strong economy, the recession will be “relatively short and shallow”.

A recent survey of 5,000 businesses buy the British Chambers of Commerce (BCC) showed that it is not just the Item Club who feels that the UK has entered a recession.

The Item Club predicts that firms are likely to see their profitability squeezed further, and say that companies will invest 5 percent less in 2009.

As a result of the slowdown, cuts in investment and employment across the UK are “inevitable”. It said that it expects unemployment to reach 5 percent by the end of 2009, double the rate of 2007.

The report comes after recent data from the Office for National Statistics showed how weak the job market has become. Unemployment rose by 164,000 in the three months to August, compared to the previous quarter – the biggest rise in 17 years.

The crunch has affected small retailers and large chains too, with consumer spending down considerably. “Last year consumers were able to handle the income squeeze by borrowing and dipping into their savings,” said Mr Spencer.

The Item Club said that the government’s recent £400bn rescue plan had pulled the UK back “from the brink” but said that the banking system was in “intensive care”.

The report says that we should be looking for a global solution, rather than dealing with the situation in isolation.

“We desperately need a global solution given the heavy dependence of our banks and borrowers on cross-border banking flows”.

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