Bank warns of sharp slowdown in UK economy

Bank Governor Mervyn King warned that UK growth is expected to be less than two per cent by the end of the year, a sharp fall from the current rate of three per cent.

He also said interest rates may have to be cut further to prevent the economy falling into recession.

Mr King said: "The challenge for the MPC (Monetary Policy Committee) is to balance two conflicting risks.

"On the downside, a sharper slowing in activity would threaten to pull inflation below the target.

"On the upside, if the central projection were to materialise, then, by the end of this year, inflation will have been at or above target in all but five months in three years."

Mr King, speaking in the Bank's quarterly inflation report, said that cutting interest rates to 4.5 per cent - as some analysts have demanded - would see CPI (Consumer Price Index) inflation soar to more than 3 per cent.

But he added that the UK was unlikely to see a full-blown recession, with lower interest rates and a weaker pound due to help growth recover next year.

However borrowers do look set for some relief, with the report predicting that inflation would fall short of the target in two years time if rates were kept at 5.25 per cent - meaning more stability for homeowners with mortgages.

The Bank also warned that the outlook for economic growth falls back "markedly" as the ongoing credit crunch takes hold.

Mr King said fears over the extent of the fall-out in the banking sector were fuelling the credit crunch and urged banks to come clean over their losses in the upcoming reporting season.

He said: "The issue is not liquidity, the concern is counter-party credit risk and concern about the balance sheets of other banks and how big the losses will be."

Figures yesterday showed that CPI rose further above target to 2.2 per cent in January from 2.1 per cent in December - with fears of inflation soaring further next month- as steep hikes in petrol and food prices pushed up the cost of living.