Britain's leading employers' organisation warned Gordon Brown yesterday that unemployment would crash through three million, just ahead of the likeliest date for the next general election.

In its latest snapshot of the economy, the CBI said 2009 would see the single biggest drop in output of any year since the second world war and lead to a rise of more than a million in the jobless total by early 2010. The prime minister has to hold an election by the spring of next year, but the CBI said the economic news over the next 18 months would remain grim.

"Firms are making cutbacks much quicker than in previous recessions because they are worried about lending," the CBI said. Average earnings growth is expected to weaken over the first three quarters of the year to a low of 1.1% as more people accept pay freezes and cuts.

The CBI is revising its forecasts down sharply and now expects the economy to contract by 3.3% this year, down from its previous forecast in November of a 1.7% decline, as the global economic downturn continues to worsen. It expects GDP growth to flatten out at 0% in 2010.

Ian McCafferty, the CBI's chief economic adviser, said: "Given the rapid contraction in global economic activity, and the continuing credit squeeze, we believe the UK will be mired in a deep recession for the whole of 2009, lasting six quarters in total and accompanied by a significant rise in unemployment."

This prediction is much gloomier than the International Monetary Fund's forecast of a 2.8% annual drop - the worst prediction its has made for any of the G7 countries. "Faced with a global confidence crisis, a rapid fall in demand and credit constraints, UK firms have been forced to scale back investment and cut jobs," said Richard Lambert, director general of the CBI.

The CBI said the situation would worsen if the government did not take immediate action. "Ultimately the severity of this recession will depend on the speedy implementation of the government's measures to unblock the credit markets and the success of various global stimuli packages in repairing business and consumer confidence," said Lambert.

The impact of the recession and the fiscal stimulus will take its toll on the public coffers, with the CBI forecasting that net borrowing for 2009/10 will reach £149bn and £168bn in 2010/11, which represent 10.6% and 11.8% of GDP respectively.

The speed and severity of the recession, combined with the impact of lower energy prices and the recent VAT cut, will push CPI inflation to a low of -0.1% in the third quarter of this year, the CBI said. In 2010, it expects inflation will remain under the Bank of England's official target of 2%. Interest rates are expected to stay at a very low level until the end of 2010.

At the Bank of England's quarterly inflation report this week, Bank governor Mervyn King said the Bank rate did not have to go to zero, because "we're getting to the point where it doesn't make a great deal of difference where it is".

The CBI said that manufacturing output would fall sharply by 10.1% in 2009 while business investment is expected to drop by 9.2% and investment by construction firms in private housing is set to dive by 23.5%. It expects house prices to plunge 15.5% this year and by a further 6.7% in 2010. "We do not see any sustainable pick up in the housing market until we see a pick up in the economy as a whole and that won't happen until business confidence is restored," said McCafferty.

Lambert indicated that he believed the VAT cut had been largely ineffective. He said if he was asked if using £12bn on reducing VAT from 17.5% to 15% was a good way of spending public money, he would say no.

"The most urgent requirement is to get the credit support schemes, announced recently, underway," said McCafferty. "Faced with continued uncertainty about access to credit, firms will continue to take drastic action to protect their businesses. But if we can get credit flowing across the economy, the considerable monetary and fiscal stimuli already in the pipeline should start to feed through later in the year and provide the pre-conditions for an eventual recovery through 2010."

VAT cut 'no help'

More than 90% of British firms believe the government's VAT cut has failed to help their business. In its monthly business survey, the British Chambers of Commerce (BCC) found 76% of firms said it had been of no benefit, while 16% said it was a burden. The BCC also found an increasingly pessimistic mood about turnover prospects, with 43% of firms predicting declines of up to 50% in the next three months. In a sign that cashflow remains a serious problem, 28% of firms said they planned to reduce working hours in the coming quarter.