The 1.9% fall in GDP in the first quarter represents the largest quarterly drop since a strike-related 2.4% plunge in the third quarter of 1979. GDP has now declined 4.1% from its peak in the first quarter of 2008, which compares with peak-to-trough falls of 2.5% in the 1990-91 recession, 3.3% over 1973-75 and 5.9% in the 1979-81 slump.

The chart shows the current fall in GDP together with Treasury and Bank of England forecasts and the 1979-81 decline, rebased to the peak in the first quarter of last year. The first-quarter result was 0.8% lower than implied by the central projection in the Bank’s February Inflation Report. The MPC judged that the latest indicators were broadly consistent with this forecast at its April meeting so today’s number could boost the chances of an expansion of QE.

The Treasury’s Budget forecast implied that GDP would fall by 2.2% between the fourth quarter of 2008 and the second half of 2009. This looked hopeful even before today's news of a 1.9% first-quarter loss. A monthly GDP estimate derived from data on industrial and services output was 0.4% below its first-quarter average in March, suggesting a further fall of at least this amount in the second quarter.

The Treasury projects a recovery in GDP of 2.9% per annum between the second halves of 2009 and 2011. While widely derided, this is lower than the 3.3% pa increase over the same period forecast in the Bank of England’s February Inflation Report. A key issue is whether the Bank will retain this steep recovery profile, albeit from a lower base, in its next Report, released on 13 May.

The 1.9% first-quarter decline is difficult to reconcile with available expenditure data. With retail sales rising by 1.0% in the first quarter, overall consumer spending seems unlikely to show a decline larger than the 1.0% recorded in the fourth quarter. Trade figures for January and February signal little impact from net exports. Meanwhile, output of “government and other services” rose in the first quarter, suggesting higher general government consumption. The implication is that GDP weakness was driven by investment and stocks.

Destocking already amounted to 1.3% of GDP in the fourth quarter, based on current data. This offers a glimmer of hope – a faster cut-back in the first quarter would imply a correspondingly larger future boost to GDP when stock levels stabilise.

The Budget "Red Book" paints a dire picture of the state of the public finances. It is tempting to suggest the Chancellor has exaggerated the gloom to create room for favourable “surprises” ahead of the election but the assumptions underlying the projections look, if anything, too optimistic.

• In the five months since the Pre-Budget Report, forecast net borrowing in 2010-11 has ballooned from £105 billion to £173 billion. Collapsing receipts account for £48 billion of this increase, with the remaining £20 billion due to higher expenditure.

• Receipts could yet undershoot even this revised forecast. The ratio of taxes to GDP is projected to bottom at 33.0% in 2009-10 before recovering but reached a low of 31.8% after the less-severe recession of the early 1990s.

• The Augustinian approach to spending discipline is maintained. Longer-term projections benefit from cuts to previous plans but the expenditure-GDP ratio surges to 48.1% in 2010-11 – the highest since 1982-83 and up from 41.0% as recently as 2007-08.

• After a 3.5% drop this year, GDP is forecast to grow by 1.25% in 2010, 3.5% in 2011 and 3.25% per annum in later years. While not unreasonable, this is clearly at the optimistic end of the range of possible scenarios.

• The Budget changes were modest in terms of sums dispensed. A net “injection” of £5.2 billion in 2009-10 is reversed in 2010-11 as the tax hike on higher-earners kicks in. The key measures this year are a temporary boost to capital allowances (costing £1.6 billion), phasing-in of the uprating of business rates (£700 million), employment initiatives (£890 million) and winter payments to pensioners (£600 million).

• The planned hike in the income tax rate on high-earners to 50% will tie the UK with Japan at the top of the G7 league table. This will create significant negative economic incentive effects and is unlikely to raise the amounts projected, especially if capital gains tax is kept at the current 18%.

• With the rise in net borrowing fully reflected in the “central government net cash requirement”, the Debt Management Office projects net gilt sales of £220 billion in 2009-10, up from £146.5 billion in 2008-09. The Bank of England, however, will absorb at least £55 billion – the gilt market's day of reckoning may be delayed until 2010-11, when a similar level of funding will need to be raised without Bank support

The macroeconomic judgement underlying the Chancellor's strategy is that higher borrowing will deliver an economic stimulus even though households and companies anticipate a significantly higher tax burden in years to come. This would be questionable in normal times but is even less likely given the unprecedented scale of necessary future fiscal adjustment bequeathed by Mr. Darling to his successor.

The plunge in sterling has pushed the gap between UK and Eurozone consumer price inflation to its highest level since 1992 – despite the UK number being artificially depressed by December’s VAT cut.

Slower food and energy price gains caused UK annual CPI inflation to ease from 3.2% in February to 2.9% in March but the equivalent Eurozone measure slumped from 1.2% to just 0.6%. The difference of 2.3 percentage points between the UK and Eurozone increases is the largest since a 2.8 point divergence in March 1992 – see chart.

The gap would be significantly larger but for the VAT cut. The CPI at constant tax rates (CPI-CT), which assumes that the reduction was passed on in full, rose by an annual 3.9% in March – one percentage point more than the headline measure. Some retailers have used the cut to boost margins: a conservative assumption that only half of the reduction has been transmitted to consumers would imply “true” CPI inflation of 3.4%, 2.8 percentage points above the Eurozone level.

The gap can be attributed roughly equally to differences in food and energy price trends and “core” inflation – both have been affected by the fall in sterling. The UK CPI excluding unprocessed food and energy – a measure of core prices – rose by an annual 2.3% in March, or 2.9% assuming 50% pass-through of the VAT cut, versus an increase of just 1.5% in the equivalent Eurozone index.

The IMF’s latest World Economic Outlook is downbeat on recovery prospects, based partly on an analysis of business cycles in 21 economies since 1960, showing that recessions associated with financial crises or with a strong global element tend to be longer and followed by weaker upswings.

The IMF’s findings, however, are at odds with longer-term historical evidence that “deep recessions are almost always followed by steep recoveries” – a regularity known as the “Zarnowitz rule” after the distinguished US business cycle analyst Victor Zarnowitz (quoted by former IMF Chief Economist Michael Mussa in a recent paper).

The table below, documenting the six largest declines in US industrial output between 1880 and 1960, illustrates Zarnowitz’s observation. The 1929-32 slump clearly stands out in terms of severity and duration. The other five recessions / recoveries show considerable similarity – contractions were deep but lasted no more than 14 months, while subsequent recoveries were strong, with peak output regained within 19 months.

These five recessions include downturns associated with a severe financial crisis (e.g. 1907-08) and / or globally-synchronised weakness (e.g. 1920-21).

The 18% fall in Group of Seven (G7) industrial output since its peak in February 2008 is in the middle of the range of these five severe US recessions (excluding the 1929-32 slump). The US historical experience suggests that the output fall – 12 months in duration as of February, the latest data point – should be approaching an end. If the recovery were also to follow the US historical pattern, output would regain its February 2008 level by late 2010 at the latest. This would imply a growth rate of output during the recovery phase of about 11% per annum – far higher than suggested by the IMF’s gloomy forecasts.

Indicators supporting a V-shaped recovery include surging G7 real money growth and a widening gap between retail sales and production, suggesting a potential big boost from the stocks cycle. Credit conditions, however, remain restrictive, though have started to ease, a process that could gather pace if investor risk appetite returns.