The Bank of England is warning that Britain has probably entered a recession which is likely to continue well into 2009.

In the Bank’s Quarterly Inflation Report, it has warned that the economic landscape has dramatically altered since August, and it now predicts that the UK’s economy could shrink by a further 2% over the next year, and to sink to 1% by 2010.

Mervyn King, the Bank of England’s governor has said: “[It is] very difficult to know precisely how long we’ll be in recession…I think we probably are in recession now.
This is a difficult and unprecedented time, but we will come through this… We will come out of recession and get back to a period of low and steady inflation and economic growth.”

This comes after records show that unemployment has hit its highest levels in 11 years, while the value of the pound plummeted further on international markets.

The Bank’s central projection is for economy to contract sharply next year. This however, is subject to change if the government introduces further fiscal stimulus to the economy.

Ross Walker from the Royal Bank of Scotland has said that markets were surprised by how big the fall in inflation that the Bank of England had projected was, but he added that he believes: “conditions are going to get worse before they get better.”

Just last week, the Bank of England shocked the country by cutting its UK interest rates to 3%. Mr King said reasoning behind the sharp fall was “because the facts had changed”, and not because the Bank was caught unawares by the crisis.

If the Bank’s rates do fall below 2% as predicted, this will be their lowest rate of interest since it was set up in 1694.

Mr King also admitted that Retail Price Index, including house prices, could fall into negative percentages as interest rates fell. The fact that oil prices are still falling will not help matters. They are now well below $60, less than half the price it peaked at during the summer.

Charles Bean, deputy governor, predicts that the contraction of the economy should be similar to the recessions in Sweden, Finland and Norway in the 1990’s, which were quite short. He also emphasised that the government have responded relatively quickly to the threat, therefore the effects of the recession shouldn’t be extended too far.

Putting a positive spin on the 20% decline of the pound, he said it could help boost exports and pull the economy out of recession.

The governor pointed out however, that if the value of the pound falls much further, there could be further inflation in the future.

As part of its action against recession, the government announced it would spend billions to protect financial systems and boost the UK economy.

According to Mr King, there is stronger argument for fiscal stimulus than before, because the banking crisis meant that monetary policy was less likely to be effective.

However, he has also warned that any fiscal stimulus must be temporary and consistent with the long-term path of fiscal discipline, otherwise long-term interest rates would rise, undoing some of the effects of any economic increase.

Prime Minister, Gordon Brown has also said that he would have to employ “very special means to deal with special circumstances” and that the economic changes needed to be world-wide in order to be most effective.

It is thought more information on this will be included in the Pre-Budget Report, due out on 24th November.