G-7 to Contract Most Since Great Depression, Deutsche Says

By Jennifer Ryan

Oct. 20 (Bloomberg) -- The economy of the Group of Seven nations will contract by the most since the Great Depression next year as tighter credit markets hurt consumption, forcing central banks to cut interest rates, Deutsche Bank AG said.

The combined G-7 will contract 1.1 percent in 2009 after expanding 0.8 percent this year, Deutsche Bank economists Peter Hooper and Thomas Mayer said in a research note. The U.S. will shrink 1 percent, the euro region will contract 1.4 percent and Japan will shrink 1.2 percent, they said.

The economic slump follows a yearlong credit squeeze that's toppled banks including Lehman Brothers Holdings Inc. and culminated in the Standard & Poor's 500 Index's worst weekly decline since 1933. Higher credit costs will strangle consumer spending and business investment just as unemployment rises, the Deutsche Bank economists said.

``We now expect a major recession for the world economy over the year ahead,'' Mayer and other economists said. ``A major cutback in credit to the real economy across the world has led to the deterioration in the outlook. We were not anticipating such a huge financial shock since our Oct. 3 forecasts.''

The G-7 consists of the U.S., Canada, Japan, France, Italy, Germany and the U.K. Growth across the world economy as a whole will slow to 1.2 percent from 3.2 percent this year, the slowest since the early 1980s, according to Deutsche Bank forecasts.

A global recession and cooling inflation will give the Federal Reserve, the European Central Bank and the Bank of Japan scope to help the economy with lower rates, Deutsche Bank forecast.

Fed Cuts

The Fed will cut the benchmark interest rate to 1 percent at its Oct. 29 meeting from the current 1.5 percent, Deutsche Bank said. It previously predicted rates to fall to that level over a period of 12 months and the economy to stagnate in 2009.

Mayer said he hasn't cut economic forecasts ``by such a large amount in such a short period of time'' in the 20 years he's been working in finance.

The ECB will lower its key rate to a record 1.5 percent over the next 12 months from the current 3.75 percent, Deutsche Bank said. The economists previously forecast the central bank to cut to 3 percent over the period and the economy to shrink 0.2 percent next year.

The Bank of Japan will lower its benchmark to 0.25 percent in early 2009, against an earlier forecast of no change, Deutsche Bank said. The rate is now 0.5 percent. The economists also said Japan's economy would shrink 1.2 percent, which compares with a previous forecast that it would expand 0.4 percent.

Global inflation will slow to 3.1 percent from 5.6 percent this year, Deutsche Bank said. The forecasts exclude data for economic growth during World War II, Deutsche Bank said.

To contact the reporter on this story: Jennifer Ryan in London at Jryan13@bloomberg.net