The Bank of England yesterday gave its bleakest economic assessment for more than a decade.

Mervyn King, the Bank of England governor, said the British economy required a 'painful' adjustment to higher energy and food prices, predicting the economy would grind to a halt for a year before recovering, probably to a slower growth path than before. There was 'bound to be a quarter or two' of economic contraction, he said. Official figures on Wednesday showed unemployment rose by 60,000 in the second quarter, a jump from the 13,000 recorded in the first quarter.

Mr King predicted inflation would peak at 5 per cent at least, restricting the room for easier monetary policy. But markets interpreted the overall assessment as a strong signal of lower interest rates to come. Sterling fell more than 1 per cent against the dollar, the euro and on a trade-weighted basis. At times it lost more than three cents against the dollar and finished the day in London at $1.8712.