A six-month swine flu pandemic in the UK could cost the economy about £60bn and extend the recession by around two years, an economic thinktank warned today.

Oxford Economics said a pandemic was likely to hit the UK just as its starts to recover from recession and could result in the credit crunch being much worse that it would otherwise have been, tipping the economy into deflation.

The thinktank predicted that a severe pandemic could cut gross domestic product by 5%, with the economy shrinking by about 7.5% next year and enduring 1% deflation throughout 2010-12. It said a pandemic would lead UK consumers to save more and spend less.

The report concluded: "There is a significant risk that the pandemic triggers a set of unfavourable behavioural changes that tip it into deflation. A flu outbreak in the autumn would hit just as the economy starts to recover from the credit crunch. It would threaten already fragile businesses and put further strains on financial markets and fiscal balances.

"This could generate a vicious cycle that postpones the recovery for another couple of years. The fact that UK households' balance sheets are more stretched than in many other countries makes the risk of deflationary dynamics larger than elsewhere."

The thinktank has previously warned that a six-month pandemic could cut world GDP by 3.5%, or about $2.5tr (£1.5tr).

Its economic forecast is based on the assumption that 30% of the UK population contracts the H1N1 virus, with 0.4% of those infected dying. This scenario is worse than the most pessimistic prediction set out yesterday by the government's chief medical officer, Professor Sir Liam Donaldson, of about 30% falling ill and a mortality rate of 0.35%, producing 65,000 deaths.

Lyndon Bird, technical services director of the Business Continuity Institute, said the Oxford Economics prediction was "frightening" and about twice as bad as his own organisation has estimated.

Bird told Channel 4 News yesterday that much of the emergency planning for the economic impact of a pandemic was misdirected. He warned that there was too much emphasis on large businesses, which were better able to cope with staff sickness, and not enough on smaller companies and the impact on consumer spending.

"Small businesses are going to be very badly hit," said Bird. "They are not necessarily going to be able to cope."

For example, a small, four-man building and decorating service could expect to be shut down for two weeks, he said. The Treasury should consider giving emergency assistance, such as tax breaks, to small businesses in the event of a prolonged pandemic, he added.

The analyst said the main concern of many businesses in a pandemic would not be that a fifth of their workforce was off sick but that 80% of their customers were ill. He said the leisure and travel industries would be particularly badly hit.