Britain is on the verge of a stagflationary recession with prices galloping out of control and demand drying up.

That is the conclusion from the worst manufacturing statistics in seven years which economists derided from " concerning" to "dismal" to "truly dreadful".

The FTSE 100 caught the gloom too, falling 140 points to 5485.9, close to an 18-month low and a fall of nearly 20% from its peak last summer before the credit crunch.

The Purchasing Manangers Index (PMI) today reported a staggering drop in industrial sentiment and conditions, falling from a downwardly revised 49.5 in May to 45.8 in June.

Not only is that muchworse than anyone in the City had feared, it is the worst reading since the last quarter of 2001 when the world was reeling from the effects of the 9/11 terrorist attacks.

A PMI reading of 50 indicates the manufacturing sector is balanced between boom and bust and so such a sharp downward fall indicates confidence is slumping fast.

Detailed readings of manufacturers' sentiment made even worse reading. Output, new orders, exports and employment outlook have all dived way below 50.

Meanwhile, factory gate price increases are surging, but are being outstripped by manufacturing costs, notably fuel, which are higher than at any time in at least the last two decades

"After pointing to stagflation in May, the UK manufacturing sector saw conditions worsen considerably in June," said Roy Ayliffe of the Chartered Institute of Purchasing and Supply.

"Faced with a relentless onslaught of ever weaker domestic demand, slower global economic growth and record cost inflationary pressure, manufacturers scaled back production which contracted at the most severe levels in nearly a decade."

Royal Bank of Scotland chief economist Geoffrey Dicks said: "This is a dismal combination of the slowest growth in output and new orders for almost a decade alongside new record highs in inflation. The outlook for the sector has become significanly bleaker."

Paul Dales of Capital Economics said: "Activity is slowing very sharply. The manufacturing sector appears to be on the verge of recession."

Howard Archer of Global Insight said: "This is a truly dreadful report."

One bright spot for manufacturers has been the weakness of the pound, making their goods more competitive.

But even that provided bad news today as sterling rose above $2 for the first time in three months before slipping back to $1.9968.

MPC'S HEADACHE

When the Bank of England's monetary policy committee sits down next week to set interest rates, it will do so with the biggest collective headache in its 11-year history. Today's manufacturing figures have set even more of a conundrum as the City tries to guess how inflation will be tackled and how Governor Mervyn King will attempt to avoid having to write further letters to the Chancellor on the committee's failures. "Sharply contracting manufacturing activity and sharply rising prices provides ammunition to both those arguing for interest rate hikes and those for cuts," said Global Insight's Howard Archer. "The ultimate next move by the Bank will be to cut rates but most probably not before 2009"