Britain’s already struggling economy would be pushed into a two-year recession by a no-deal Brexit, the International Monetary Fund has warned.

Ahead of Theresa May’s plea to EU leaders for a further delay to Britain’s departure, the IMF used a downbeat half-yearly assessment of the global economy to predict that the UK economy could be 3.5% smaller than expected by 2021 if trade barriers were swiftly erected.

The World Economic Outlook – completed in March before the latest developments in Brexit – predicted UK growth of 1.2% in 2019 on the assumption that a Brexit deal is done.

Growth in 2020 has also been revised down – by 0.1 points to 1.4% – since the fund’s last WEO in October, but the IMF said its projections were surrounded by uncertainty.

It said there were alternative no-deal scenarios in which the UK would be hit by trade barriers, customs delays, barriers to financial services firms and the loss of preferential access to non-EU countries under trade deals negotiated by Brussels. The impact of these would be enough to cause output to decline in 2019 and 2020.

It stressed that “a no-deal Brexit that severely disrupts supply chains and raises trade costs could potentially have large and long-lasting negative impacts on the economies of the United Kingdom and the European Union”.

The Washington-based IMF said some of the damage would be mitigated if the two sides recognised existing product standards, at least temporarily.

“The extent of the border disruption and the tightening of financial conditions are also very uncertain, as is the degree to which financial sector output would decline in the long term due to the loss of passporting rights.”

Despite the pick-up in wage growth prompted by the lowest unemployment since the mid-1970s, the IMF said Brexit uncertainty meant that the Bank of England should be wary of raising interest rates and the chancellor, Philip Hammond, should be prepared to cut taxes and raise public spending if growth slowed markedly.

The WEO said the EU could suffer a 0.5% drop in output by 2021 after a no-deal outcome, and was already suffering from a period of weak activity.

Forecast growth in the euro area for 2019 has been revised down by 0.6 points to 1.3% due to a combination of factors: weakening consumer and business sentiment; delays associated with the introduction of new fuel emission standards for diesel-powered vehicles in Germany; the impact of the row over Italy’s budget on borrowing costs; the yellow vest protests in France; and the impact of growing concerns about a no-deal Brexit on investment.

Every member of the G7 group of industrial countries is believed to be growing more slowly in 2019 than the IMF predicted in its October 2018 WEO and in an updated forecast published three months ago. Global growth is expected to be 3.3% this year, a 0.4-point cut since last autumn. Activity is expected to pick up in the second half of the year.

Gita Gopinath, the IMF’s chief economist, said: “While the global economy continues to grow at a reasonable rate and a global recession is not in the baseline projections, there are many downside risks. Tensions in trade policy could flare up again and play out in other areas, such as the auto industry, with large disruptions to global supply chains.

Sign up to the daily Business Today email or follow Guardian Business on Twitter at @BusinessDesk

“Growth in systemic economies such as the euro area and China may surprise on the downside, and the risks surrounding Brexit remain heightened. A deterioration in market sentiment could rapidly tighten financing conditions in an environment of large private and public sector debt in many countries, including sovereign-bank ‘doom loop’ risks.”

The IMF said that since early 2018, protectionist measures by the US and retaliation by its trading partners had damaged sentiment. It urged that policymakers settle their disagreements without raising tariffs and other barriers to international trade. Doing so would avoid making the global slowdown worse.

“This is a delicate moment for the global economy,” Gopinath said. “If the downside risks do not materialise and the policy support put in place is effective, global growth should rebound. If, however, any of the major risks materialise, then the expected recoveries in stressed economies, export-dependent economies and highly indebted economies may be derailed.”

Gopinath said of Brexit: “The situation is in flux on a daily basis. It is hard to know where it will end up. We have seen the negative consequences of the uncertainty surrounding Brexit on investment in the UK and that’s one of the reasons for the downward revision to UK growth.

“We hope there is a deal soon. We are watching events as they unfold.”