One of the world's biggest investment banks tonight warned Britain is careering headlong into its worst economic crisis for a generation.

JPMorgan Chase Bank said the UK faces the "twin demons" of recession and runaway inflation - a poisonous cocktail not seen since the early 1990s.

"The coming months will provide a major test of the UK's economic resilience," says a report by the bank's City economists Malcolm Barr and Allan Monks. "Our central forecast is for a slowing in growth which is deeper and more prolonged than seen since the early 1990s."

This will make grim reading for Gordon Brown and Alistair Darling, whose reputation for economic competence has been shattered since the collapse of Northern Rock last year.

The report comes as the Chancellor and Bank of England Governor Mervyn King prepared to exchange open letters to address the deteriorating situation. They will be forced to write to each other tomorrow if, as expected, official figures show inflation rose above 3% last month, driven higher by food and energy prices.

Oil hit a record high of $139.89 a barrel in New York tonight while the housing market continues to be buffeted by falling prices and a lack of mortgage lending. Barr and Monks say that the UK economy "faces twin demons that have plagued it in the past but have been dormant for almost a generation: rising inflation and the possibility of a housingled recession."

They add that there is a 40% chance of a "technical recession" - two consecutive quarters of negative economic growth - and a 20% chance of the sort of "sharp and protracted contraction" last seen some 16 years ago.

Outright recession "will be avoided", they believe, while warning that this forecast "is attached by an unusually high degree of uncertainty".

The bank's report points towards weak growth in household incomes, high borrowing costs, falling house prices and job losses - all of which will hit consumer spending. "The key question is not will consumer spending growth slow, but by how much," it says.

Barr and Monks also warn that inflation is likely to peak above 4% - preventing the Bank of England from cutting interest rates despite the slowdown in the economy.

The Bank has cut rates three times since December, from 5.75% to 5%, but now looks set to leave them unchanged until inflation returns towards the 2% target. It is forecast to hit 3.1% or 3.2% tomorrow and fears are rising in the City that the Bank will in fact raise interest rates to bring inflation under control. King could use tomorrow's letter to allay such concerns.

In Europe, inflation today soared to its highest since 1992, driven by food and energy costs. Eurozone statisticians said it rose to 3.7% last month, piling further pressure on the European Central Bank to raise interest rates from 4% to 4.25% next month.