Interest rates are set to be cut at least twice by next summer — and up to three times next year — to stave off a sharp downturn in the economy, the Bank of England signalled yesterday.

In its gloomiest view of prospects since 2001, the Bank sounded a warning that, even after these likely cuts in rates, growth is still set to suffer a severe setback next year, triggered by past rate increases and the mounting impact of the global credit crunch.

But Mervyn King, the Governor of the Bank, issued a clear signal that it is now poised to reduce rates to shore up growth as dearer loan costs sparked by the credit crisis, a rapidly weakening housing market and a growing squeeze from soaring fuel and food prices all take a heavy toll on consumer spending and lead people to save more.

The Bank said that the economy would also be hit hard as growing nervousness, as well as more expensive borrowing for companies, led businesses to rein in investment plans, while the commercial property market faces a slump.

The downbeat Governor said that the Bank’s central view of the outlook for the economy “is for growth to slow sharply over the next year”, making clear that it will be on alert over big risks and uncertainties that could lead to a yet bleaker outcome.

In sharp downgrades to its forecasts, the Bank predicted that, compared with boom-like annual growth of more than 3 per cent in the third quarter, the faltering economy could slow to expand by less than 2 per cent at its weakest next summer.

Despite this steep slowdown, however, Mr King also made clear that the Bank’s rate-setting Monetary Policy Committee (MPC) is still wrestling with nagging anxieties over persistent inflationary pressures that are now being inflamed by record oil prices and the surging cost of food.

These continued inflation worries mean the timing of the Bank’s first rate cut is still uncertain. Economists predicted that it is likely to come by February, with a slim chance of a cut next month.

Three quarter-point cuts in base rate, taking these to 5 per cent, could eventually reduce monthly repayments on a typical £150,000 mortgage by £69, to £909. Two rate cuts would make such a mortgage cheaper by £47, the Council of Mortgage Lenders said.

But Mr King emphasised that when the MPC acts will depend on whether key economic figures quickly confirm the slowdown the Bank expects to see.

“There will be some difficult decisions in the months ahead,” he said.

He highlighted the dilemma inflicted on the Bank by the conflict between weakening growth and rising inflation that is being stoked by oil prices now close to all-time highs of $100 a barrel.

After figures this week showed that inflation last month jumped back above its 2 per cent target, the Bank is forecasting that pressures from fuel and food costs, and a falling pound, will lift it still higher during next year.

But the Bank’s view is that, without interest rate cuts, inflation will then tumble back to markedly below its target in early 2009 as a more severe economic slowdown sharply reduces price pressures.

Mr King said that while the Bank’s report pointed to what “looks like a very sharp slowdown”, it was “not that sharp”. But he admitted that “in the short run, undoubtedly, there is a risk . . . of a bigger downturn”.

He said that the Bank had believed that some slowdown was needed to quell inflation. The key question was whether “the slowing we are going to see bigger than we had wanted to see”.

Some experts argued that the Bank is still taking too rosy a view, especially over the impact on consumers of an end to the housing boom, as surveys show house price falls in many areas,

But playing down the effect of house prices on consumers, Mr King argued that there had so far been only “mixed signs” from the property market. “How far it goes remains to be seen,” he said.

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