Mervyn King today gave his gloomiest assessment yet of the state of the economy as Britain flirts with recession and the cost of living soars.

The Governor of the Bank of England said he expected the economy to grind to a halt over the next 12 months and did not rule out recession.

At the same time, he forecast inflation will rocket to 5%, or even towards 6%, driven by the rising price of food and fuel. The Bank previously expected inflation to peak at around 4%.

It sent the pound tumbling against a host of world currencies as the outlook for the UK economy looked ever grimmer. Sterling was down 2.12 cents against the dollar at 1.8758.
Such a toxic mix of stagnant growth and runaway inflation — known as stagflation — has not been seen here since the recession of the early 1990s.
King said: “The adjustment of the UK economy to higher commodity prices and a more realistic pricing of credit will be painful.

“The next year will be a difficult one with inflation high and output broadly flat...I think with broadly flat output, it's bound to be the case that there is a possiblity of a quarter or two of negative growth.”

It was a bitter blow to Gordon Brown and his crumbling reputation for economic competence.

Figures today showed unemployment rising at its fastest rate since December 1992, just 24 hours after separate numbers revealed inflation hit 4.4% in July — its highest since April 1992 and more than double the 2% target.

King said: “There is a feeling of chill in the economic air. The British economy is going through a difficult and painful adjustment to higher energy and commodity prices, and in banking, credit and housig markets.”

Inflation is being driven higher by the rising price of food — up 13.7% on a year ago — and fuel. British Gas last month put up gas bills by 35% while EDF imposed a 22% hike.

However, King also forecast inflation to fall back to 2% or below in the next two years, as well as a return to economic growth. “We will come through this,” he said. “We will return, if not to the nice' decade, then at least to one that is not so bad.”