G7 set for year-long recession

LONDON (Reuters) - The world's leading economies will likely be in recession for around a year with the UK hit particularly hard, while dramatic rates cuts and fiscal measures should cushion the blow, a Reuters poll showed.

Unprecedented falls in world markets over the past month have shredded any doubt that leading economies will escape from the mess of the credit crisis any time soon. But economists say for now that fears of deflation, apart from in Japan, are overdone.

Policymakers were sent scrambling in October and into November to find measures to restore some balance, even calling a wider G20 meeting, but it looks too late to stop a lasting recession setting in even if it may not be as deep for some as in the past.

A survey of around 250 economists across the Group of Seven nations showed economies facing a recession for either four or five quarters in the case of Japan and the UK. Last month the U.S. economy was forecast to contract for three quarters.

"All developed economies will contract in 2009. It's the worst we have had in a century. But to say it's going to look like 1929 again for all these economies is a bit excessive, it's too pessimistic," said Marco Annunziata, chief economist at UniCredit.

He said the UK would suffer the most given its dependence on its now weakening financial sector, high indebtedness of its consumers and still falling housing market. The U.S. would lead the fightback next year.

The survey showed nearly all economies facing contraction next year, with the UK leading the bunch with a predicted fall of 1.3 percent, the euro zone 0.4 percent, while Japan is forecast to contract in the next two fiscal years.

A pick up in the U.S. to come in the second half will see its economy post growth next year of 0.4 percent.

Forecasts for the current year have also been rewritten.

Economists said that central banks, especially those of the euro zone and UK, will continue to hack away at rates in coming quarters to leave them at levels better suited to a sudden slowdown in both growth and inflation. The U.S. Federal Reserve also looks ready to trim rates even further.

Fiscal measures, some of which may be seen in the UK government's Pre-Budget Report to be released on Monday, should offer some relief from what has been a near daily build-up of dire news in the past month that confirmed the euro zone and Japan were already in recession. A host of measures under the U.S.' Troubled Assets Relief Programme should also help its economy.

DEFLATION FEARS OVERDONE?

Inflation across the major economies is also set to fall more dramatically than previously expected as commodity and food prices tumble.

But fears of deflation, where prices are actually dropping, look to be overdone for now, apart from in Japan where negative inflation rates are seen gripping the country through the final half.

Elsewhere inflation is not forecast to slip into negative territory in any quarter in the U.S., UK or euro zone.

"Deflation concerns are a bit overdone. We tend to go from one extreme to the other. Earlier this year we were talking about stagflation as oil prices kept going up. Now we have swung to the other extreme," said Annunziata.

He said headline inflation could turn negative for some months next year in the euro zone, but it was unlikely that inflation would turn negative.

For the UK and euro zone a fall in inflation back to levels more comfortable with the central targets of both the ECB and Bank of England next year will likely make it easier for them to cut rates.

Both central banks have faced high levels of criticism for not cutting rates sooner as the Federal Reserve started to do over a year ago.

But ECB President Jean-Claude Trichet for now seems calm. "We are not in a situation that characterizes deflation. If I look at some facts and figure, I don't see yet any trace of deflation or negative inflation," he said on Tuesday.

Falling inflation should in turn promote growth, but things are not seen improving until deep into 2009.

But for the U.S. a decent turnaround at that time is seen, pulling away from its peers in the second half of the year to register growth of 1.2 and 2.0 percent in the third and fourth quarters respectively.

That could help restart the U.S. on to a solid path in 2010, dragging with it the other leading economies soon after. "The downside risks are still significant, but policy efforts should support growth in the second half of 2009," said Scott Brown at Raymond James.

(Polling by Bangalore Polling Unit; Reporting by Burton Frierson in New York, Yasuhiko Seki in Tokyo, Jonathan Cable in London; Editing by Victoria Main)