By ALEX BRUMMER

Last updated at 15:08 10 April 2008

The world is facing the biggest financial shock since the Great Depression, warns the International Monetary Fund.

And the IMF warns that Britain could be the country hit hardest by the global credit crunch as it has bigger debts than anywhere else.

In its most startling report of modern times, it says the meltdown "has inflicted heavy damage on markets and the financial institutions at the core of the financial system".

Analysis by the IMF reveals British banks will lose more than £20bn from the international mortgage meltdown, equivalent to three per cent of gross domestic product (GDP).

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Warning: The IMF's Charles Collyns is sceptical about the chances of Alistair Darling meeting his growth forecast

For the first time the IMF also predicts that the American economy is heading for recession and will shrink by 0.7 per cent this year, sending shock waves across the globe.

American banks, which it was thought would be worst affected, will lose £72 billion, or 1.4 per cent of US GDP.

Despite healthy growth in the Far East, it now believes there is a 25 per cent chance that the whole world could follow the Americans into recession.

"The financial markets crisis that erupted in August 2007 has developed into the largest financial shock since the Great Depression," the report says.

It estimates that the losses from American mortgages will reach $945billion (£500billion) - more than twice previous estimates.

The U.S. housing collapse is far from over, with the fund economists expecting a further 10 per cent decline in 2008, on top of a similar fall in prices in the previous years.

Such declines, it believes, are way beyond anything seen in the previous American experience.

Last night is also emerged that the world's leading bankers had accepted much of the blame for the credit crisis.

The Institute of International Finance, which represents more than 375 of the world's leading financial companies, said there had been 'major points of weakness in business practices'.

These included bankers' pay and risk management.

The apocalyptic language used by the fund is highly unusual and reflects an unprecedented concern about the impact of the credit crunch which has prevented banks from borrowing in the wholesale money markets, making it all but impossible to fund new mortgage lending on both sides of the Atlantic.

In Britain, the IMF warns that the "housing correction will continue to impact on consumers" and "be a drag on the economy".

The fund's top economist Charles Collyns was sceptical about the chances of Alistair Darling meeting his growth forecast for Britain of 2 per cent this year, as set out in the Budget last month.

Meanwhile speculation about the half per cent cut in UK interest rates caused the pound to fall to a record low against the euro, which was last night worth 80p.

He said that the IMF's own forecast of 1.6 per cent output expansion "was in line with the consensus".

Ahead of his arrival in Washington today for his meeting with the world's top financial leaders, the Chancellor stood by his Budget forecasts.

He said there "are grounds for optimism" despite the unprecedented shock for the economy. Britain, he claimed, "has a strong economy that has been remarkably resilient".

In contrast, the top IMF economist said: "The housing market will be a drag on the economy."

He also warned that Britain was extremely vulnerable to the cold winds blowing out of the U.S. and Europe, with the German economy also slowing rapidly.

"In the UK there are a number of factors both domestically and externally holding back the economy. We do see house prices softening and we see potential for that to continue, with an impact on consumption.

"We also see the UK affected by the tightening in financial constraints related to the turmoil in the financial market. It will also be affected by the slowdown in the U.S. and the euro area," Collyns cautioned.

Britain, in the view of the IMF, is much less well placed to deal with the downturn than our counterparts, including the Americans, because of the UK's soaring budget deficit which is expected to hit £38billion this year.

He also noted that Britain's national debt, the accumulated sum of the nation's borrowing over past years, was perilously close to 40 per cent of national output - the selfimposed limit under Gordon Brown's fiscal rules.

"There has been an upward drift in the fiscal deficit in the UK," Collyns said.

Any hope that pressure on the U.S. economy, the key to our own economic health, will improve in 2009 - when there is a new President in the White House - was brushed aside by the IMF.

"Downside risks especially for 2009 remain a concern," it cautioned.

A house price collapse in the U.S., beyond the 14 to 20 per cent built into the IMF's forecasts, "could have serious repercussions".

It could affect other economies - including those of Britain, France, Germany and Switzerland - because of the exposure of high street banks to the debts originating in the U.S.

An end was in sight for Britain's housing boom with "a sharp deceleration in house prices".

The IMF noted that in the past, house price falls, of the kind now emerging in the UK, have been a "significant factor" on the road to recession.