The Chancellor's hopes for a rapid revival in Britain's faltering economy by next year were undercut today after the International Monetary Fund (IMF) reduced its forecasts and warned that the UK faces a two year-long economic downturn.

In its annual economic health check on Britain, the IMF said that a series of heavy blows from tumbling house prices, the credit crunch and rising unemployment meant that UK growth would be a meagre 1.4 per cent.

The IMF had previously forecast 1.8 per cent growth and today's revision is below the bottom end of Alistair Darling's present 1.75 to 2.25-per-cent prediction.

In a further blow, the IMF said the economy was set to be even weaker next year, with growth over 2009 now forecast to be only 1.1 per cent, which is sharply down from the 1.7 per cent it predicted in in last assessment in the spring, and far below the Chancellor's forecast for growth of between 2.25 and 2.75 per cent.

If the IMF is correct, the rough two years for the economy this year and next would leave Britain with its worst performance since the end of the last recession in the early Nineties.

However, the fund said that, for now, it expected that Britain would skirt technical recession, defined as two quarters in a row of falling output (GDP).

The IMF has no single quarter of decline shown in its projections for the period over the next few quarters when the downturn is at its worst.

The IMF said that it expected a gradual revival in growth to begin to take hold from the second quarter of next year, with the downturn reaching its low point around the turn of this year.

As the Bank of England prepares to set interest rates tomorrow, amid widespread City expectations that it will keep the cost of borrowing on hold at 5 per cent, the IMF said that the present sharp rise in inflation meant that it had "no scope" to cut interest rates.

But amid fears that the Bank's rate-setting Monetary Policy Committee (MPC) could push rates higher this week or in coming months, today's report added: "Nor is there a clear case for an immediate increase in the Bank rate".

The IMF expects that headline consumer price inflation will climb close to 5 per cent during the next few months, and remain above the Bank's 2 per cent target.

However, it expects inflation to be back on target during 2010 — consistent with the MPC's goal to hit the target over a two-year time horizon.

After a recent report that the Treasury is working on plans to ease its strict rules for the Government's finances that could pave the way for increased borrowing and spending to help take some of the sting from the economic downturn, the IMF fired a warning shot at the Chancellor, cautioning him against any relaxation of plans to cut Britain's state borrowing over coming years.

It said that reforming the rules to allow a loosening of fiscal policy through increased borrowing in the short term would be misguided at a time when the Government is expected to be in the red to the tune of 3.5 per cent of GDP this year and next, and is set to breach the 40 per cent of GDP ceiling on the national debt set by Gordon Brown from 2009 onwards, according to the fund's forecasts.

The IMF recommended that the Treasury keep the 40-per-cent debt ceiling in place and that it draw up plans to reduce debt to this level over coming years, and by early in the next decade.

With slumping house prices a drag on growth, the IMF said that its main scenario for the UK was based on a fall in home values of "about 15 per cent" over two years, "rather than a precipitous correction". However, it noted that "some market indicators" suggested a more severe plunge in prices of 20 to 25 per cent by 2011.

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