More than a million Britons will be out of work and on the dole by next month as the toxic fallout from Black October filters down to ordinary families, economists are warning.

A bleak Christmas lies ahead for many as the City turmoil spreads into the so-called real economy. Companies are now being squeezed on two vital fronts, with shoppers abandoning the high street and bank lending drying up, making it almost impossible for smaller businesses to get credit to stay afloat.

Geoff Hoon, the new Transport Secretary, yesterday warned that there were 'potentially serious consequences for small business, for employment' from the current crisis, reflecting private warnings to the Prime Minister's new economic 'war cabinet' that job losses and business collapses later this year are now virtually inevitable.

Official unemployment figures for September, due on Wednesday, are expected to show another increase in job losses - although this will not yet be the sharp upward spike which is expected as the full consequences of last week's stock-market crash filter through. Some forecasts suggest that unemployment will hit two million by Christmas.

Some government officials warned that those slipping into unemployment could find themselves much more isolated than in the last recession. They pointed out that unemployment benefits had slipped relative to earnings and there were now fewer council houses available.

Senior Tories this weekend called for a freeze on new employment rights, in a shift away from David Cameron's previous enthusiasm for measures like extra parental leave, arguing that the priority was to save jobs by reducing business red tape. Alan Duncan, the shadow business secretary, will host an emergency summit this week on ways of preventing small businesses from going bust.

Chris Grayling, the shadow work and pensions secretary, told The Observer it would become 'more difficult' to make the case for flexible working in the darkening economic climate and called for deregulation to take the pressure off employers: 'The one thing government must recognise is that it can't keep piling regulation on small business when that could (determine) the decision whether to keep somebody in a job or not.'

Ministers are now under similar pressure to defend jobs, with some Labour MPs reporting a backlash from constituents furious that billions have been spent rescuing bankers while factory workers' jobs go to the wall.

The British Retail Consortium will release figures this week showing another fall in sales on the high street last month, with director general Stephen Robertson warning that sales for non-food retailers such as electrical stores had 'fallen off a cliff'. Some retailers are reducing opening hours to save costs.

Shoppers are also cutting back on 'big ticket' purchases like cars, with the number of new registrations in September down by a fifth on August, according to the SMMT, the motor vehicle manufacturing body. Car plants have already axed thousands of temporary staff and put others on four-day weeks or halted overtime. 'If there is no pick-up in demand for cars, there are bound to be more job losses next year,' said Roger Madison, national automotive officer for the Unite union.

Others at risk include the aviation industry - Willie Walsh, the British Airways chief executive, is predicting that up to 30 airlines worldwide will go bust - while further losses are likely in the City. Unemployed bankers are being advised to seek work in Shanghai or Mumbai amid warnings that the Square Mile will be permanently reshaped by the crisis.

'City people I speak to are despairing because they may not get another job for a year,' said Shaun Springer, chief executive of the City headhunting firm Napier Scott. 'For the first time in 30 years in the City, I'm scared.'

With charitable donations falling, even the voluntary sector is also cutting jobs. Oxfam needs to shave its budget by up to 15 per cent because of falling income, while the National Council of Voluntary Organisations expects some smaller charities to go under.

Alan Clarke, economist from the bank BNP Paribas, said the number of those claiming unemployment benefit was due to break the one million mark by the end of next month at the latest, with up to two million looking for work by December: he is forecasting unemployment to hit 7 per cent by the middle of next year and carry on rising until 2010.

Philip Shaw, economist at Investec, said it was difficult to be optimistic: 'The sentiment is one of widespread doom and gloom. Businesses are now being affected by the credit squeeze. The economy has shuddered to a halt.'

At the height of the 1980s recession, three million were unemployed. The question now is how far the pain will spread. As one boss told a senior CBI official: 'We know there is a tsunami coming, but we do not know if it's going to knock us over or just wet our feet.'

The speed with which the bubble burst is one of the most striking factors of this crisis, and could help determine what happens next. Consumer confidence is now lower on some indices than in the 1980s slump or even the mid-1970s, according to the pollster Peter Kellner, suggesting that Britons unused to tough times are quicker to panic than in previous slumps - leading to a more sudden fall in sales, and consequently a more severe immediate threat to jobs.

'It may be that paradoxically because it's been so good for the last 16 years people are not used to the idea (of bad times) whereas in previous times the boom and bust rolled around so regularly that it was less of a shock to the system,' he argues.

No wonder Labour MPs' celebrations after last week's banking bailout package were shortlived. 'The big picture is obviously deeply worrying,' said one Cabinet aide. 'But at least Gordon is playing a blinder: he looks so comfortable in his own skin for the first time in a long time.'

The Prime Minister has indeed been revitalised by the crisis, his confidence visibly soaring: he trounced David Cameron at the dispatch box last week over City bonuses, and is now seeing his stance vindicated as other world leaders rush to copy his banking bailout. Finally, he is in his political element, leading international debate. Nonetheless, Labour's long-term prospects, with an election in 2010, are unclear. Brown could survive the crash, as John Major did with re-election in 1992, or be forced from office. Brown's argument today that his banking plan will reduce the pain felt by Britain will be critical. 'If there is a slight blip but nothing too serious, and Gordon is seen to have played a major role in pulling Britain through, then I'm not saying Labour will definitely win, but it's game on,' says Kellner. 'Alternatively, if it is a disaster we could have a Conservative landslide.'

There are fears across all three parties that the British National Party may profit from rising unemployment. Grayling argues that healthy employment levels among foreign nationals have masked the loss of 250,000 jobs in the last years among British men: around half of new jobs created under Labour have gone to overseas workers. Widespread job losses among unskilled, working-class Britons could provide dangerous ammunition for extremist parties and fuel the rise of anti-immigrant sentiment.

Unions are warning that the government must use its stake in the banks to free up lending, keeping businesses afloat and protecting jobs. Hugo Sellert, head of economic research at the online recruitment firm Monster, which has seen the number of employers recruiting fall dramatically, says the biggest fear is of business lending drying up. 'We have yet to see the full impact of the financial crisis and the recent dramatic events spill over into the jobs market,' he said. 'The worst is still to come.'

Which would mean tough decisions not just for employers but for government. The Treasury's forecasts of a 4.8 per cent growth in tax receipts - including money raked in from corporate tax and VAT on consumer goods - now looks wildly optimistic, yet revising them would threaten its spending plans for public services. So what happens when the sums no longer add up?

If you are reading this on a Northern Line London Tube train, you may owe your journey to the last great recession. The extension of the Tube north to High Barnet and east into Essex in the 1930s was part of a massive programme of government spending designed to save jobs in construction and stimulate the economy after the Great Depression.

Rather than balancing its books by slashing spending or hiking taxes, could Labour try to spend its way through the recession by unleashing another era of job-creating public works?

Rail and bus operators are usually among the first casualties of rising unemployment, as redundant commuters tear up their season tickets. But Stephen Joseph, of the Campaign for Better Transport, argued the pain could be eased now by pushing ahead with expensive projects such as Crossrail.

'Because of commitments in the transport sector some of the downturn won't be as bad, because there is a level of spending through the recession,' he said. The last few days have, he argues, seen an outbreak of cross-party Keynesianism with even the Tory Mayor of London, Boris Johnson, warning against halting investment. Similarly, ministers are being lobbied to snap up land at bargain prices as the property market crashes and use it to build social housing, keeping construction workers in jobs.

The prospect of a spending spree funded by borrowing worries the Tories, who fear winning the next election only to pick up the bill for what the shadow cabinet minister Michael Gove calls a 'party on David Cameron's credit card'.

This weekend, the shadow chancellor George Osborne published an analysis suggesting that, if government borrowing rises by £40 billion to plug the gap caused by a shrinking economy, government debt will rise to £80 billion by next year. By 2009-10, the government could be spending more on servicing debt than on grants to schools.

Whitehall is tightening its belt ahead of a pre-budget report this autumn expected, as one Cabinet minister admits, to be 'very tough'. The Treasury has not yet even set a date for its publication, as Alistair Darling rips up plans left outdated by the global crisis. Downing Street has identified health, education and transport as priorities to be ringfenced but the outlook for other departments in the next three-year spending round - due to be settled next summer - appears grim.

Discussions have already begun over the Queen's Speech, ditching planned legislation that does not address bread-and-butter issues. Ironically, one of the flagship bills was intended to be James Purnell's welfare reforms, bringing in private sector firms to find work for the jobless, details of which will be published in December.

By then, if the gloomier forecasts are right, two million Britons could be needing the newly privatised Jobcentre services - but if Brown is vindicated, the economy could have stepped back from the brink.

For millions whose homes and livelihoods depend on his economic stewardship, he was right yesterday to say the stakes could not be higher.

· This article was amended on Tuesday October 14 2008. The headline of this article 'Two million Britons on the dole by Christmas' did not accurately reflect the figures used in the story. This has been corrected.