Falling oil prices could provide one of the few bright spots for the UK economy this year, helping consumers to feel that they are better off and cushioning the impact of a recession, according to research out on Monday.

Oil prices have plummeted by more than $100 a barrel since reaching a peak of $147 in July as the mounting recession in most leading economies has led to a slump in global demand. Oil now costs a little more than $46 a barrel, after falling as low as $36 in December.

If maintained, the decline in prices would help drive down inflation, deliver a rise in real incomes for consumers and boost the UK economy this year, according to a study by Ernst and Young's ITEM club.

“If oil prices stabilise at $40-$45 a barrel, that would shave quite a bit off the contraction,” said Hetal Mehta, senior economic advisor at the ITEM club.

Economists on average expect a 1.7 per cent decline in GDP next year. If oil prices hold at around $40 a barrel, the boost to the UK economy from lower costs could reach around 0.3 per cent in 2009 and 0.6 per cent in 2010, Ernst and Young estimates. But if prices slump further to $20 a barrel – which Ms Mehta gives a 10 to 20 per cent chance – GDP could be lifted by as much as 0.4 per cent this year and 0.8 per cent next.

However, analysts are on average forecasting oil prices of $58 a barrel this year and more than $70 a barrel in 2010, according to a Reuters poll.

Even if oil prices have not got much further to fall, their drop so far will still boost growth. The rise in prices earlier last year squeezed real incomes, contributing to the slowdown in consumer spending, Andrew Sentance, a member of the Bank of England’s monetary policy committee, said in a speech last month. “Over the months ahead, we should see both these effects reverse as recent falls in energy and commodity prices feed through to consumers and firms,” he said.

Lower oil prices will deliver lower production costs for companies, in turn reducing consumer prices and helping to increase businesses profitability. If oil prices remain constrained or fall further, manufacturing could deliver significantly higher output growth while exports would also benefit.

On the downside, however, sharply weaker oil prices would hit the already troubled public finances and push the global economy closer to a deflation spiral. In the pre-budget report, the Treasury said it was already projecting a 33 per cent drop in tax revenues from North Sea oil in 2009-10 because of falling prices, under the assumption that oil prices would be on average a little over $60 a barrel. If oil prices are lower still, it could mean an even larger public sector deficit.

“It is very possible that a further fall in the international oil price will spark deflation that will further damage a global economy that is already stumbling into 2009,” said Ms Mehta.

The Financial Times Limited 2009