City bonuses to plunge by £1.4bn

The shortfall is likely to major implications for the London economy, particularly the top end of the housing market and investments such as art and wine favoured by City high earners.

The prediction follows an extrordinary summer of turmoil in the financial markets triggered by the sub-prime mortgage crisis.

Over the past month, the top investment banks have written off more than $20 billion (£9.8 billion) of loans and two - UBS and Merrill Lynch - have fallen into losses.

The think tank, the Centre for Economics and Business Research (CEBR), forecast that bonues will drop by 16 per cent from last year's record £8.8 billion to £7.4 billion.

The trend of shrinking bonuses looks set to continue next year, with the group expecting payouts to fall by a further 16% to £6.2 billion in 2008, the lowest level since 2003.

CEBR economist Sarah Bloomfield said: "The outlook for the City suggests that its 350,000 employees will need to get used to a smaller payout over the next two years. However, by any measure, at £7.4 billion in 2007 and £6.2 billion in 2008, it will still be a very large bonus cheque."

The CEBR is also predicting that around 6,500 City jobs will be axed over the next two years. The trimming has already started with UBS saying that around 350 London-based jobs will go.

The private equity industry is also likely to be hit following a drastic drying up of deals since the start of the financial turmoil in July, which culminated in the spectacular run on Northern Rocklast month.

However, the cull is likely to be far worse on Wall Street, where as many as 40,000 jobs could be cut, according to one forecast.

The City bonus cut will be less severe than in previous downturns such as the dot.com collapse of 2000 and 2001.

Some banks, partcularly Goldman Sachs, have escaped the credit crunch with little or no damage.

The FTSE-100 share index and commodity prices have been resilient.

The first major test of how City spending has been reined in is this week's Frieze Art Fair in Regent's Park. Some pundits are predicting more cautious buying this year because of uncertainty about bonuses and job security. London-based dealers in luxury cars such as Ferraris report fewer "impulse" buys" this Autumn.

Jonathan Said, senior economist at CEBR, added: "We expect that the bonus cuts this year and next will take the edge off the London property market and high-end retailers' sales growth. Yet in no way will it mean a drying up of these markets."