Unemployment is surging at its fastest rate for 16 years, with the latest figures showing that the number of people out of work and claiming jobless benefit rose by 20,100 last month.

Young people are bearing much of the brunt of the increase, the largest monthly rise since the end of the recession in 1992.

Mervyn King, the Governor of the Bank of England, conceded that there was a risk that Britain would slip into recession - two consecutive quarters of negative growth - by the end of the year. Growth in the economy was set to grind to a halt and food and fuel costs would push inflation to a peak of 5 per cent or more this autumn, Mr King said. The prediction confronts Britain with the prospect of a dose of 1970s-style “stagflation”.

The scale of the downturn was emphasised by a rise in unemployment for the sixth month in a row. Revised figures also showed that unemployment rose by a steeper than previously reported figure for June, taking the increase since February to 70,000.

Under-25s accounted for 25,000 of the 60,000 rise in unemployment shown by the official Labour Force Survey during the second quarter. Last month’s rise in unemployment was fairly evenly spread across the country, with the biggest increase, of 3,200, in London and the South East.

The Bank drastically cut its forecast for growth this year and next, while predicting even higher inflation in the short term. “The next year will be a difficult one, with inflation high and output [the economy’s growth] broadly flat,” Mr King said. “The British economy is going through a difficult and painful adjustment. It may still, just, be summer, but there is a feeling of chill in the economic air.”

He admitted that there was a real danger of recession, although he made clear he did not see this as a certainty. “It’s bound to be the case that there is a possibility of a quarter or two of negative growth,” he said.

Mr King made clear that over the coming year, incomes would grow only very weakly, taking the soaring cost of living into account. For some, disposable income would drop, triggering a steeper slowdown in already faltering consumer spending, he said. At the same time, the Governor said, the economy would continue to be blighted by the credit crunch, the slump in the housing market and stuttering investment by businesses.

Britain was being hit by a double whammy of economic shocks from spi-ralling energy and commodity prices alongside the credit crunch, he said, which was “the biggest financial dislocation since the Second World War”.

The Bank’s forecasts predict economic growth of only 1.5 per cent this year, falling to a meagre 0.75 per cent next year, with sizeable risks of an even worse outcome.

But the Bank eased fears that it could be forced to raise interest rates to quell rampant inflation and hinted that rates could be cut by the end of this year, or early next. Inflation was set to fall very sharply from a 5 per cent peak in the next few months to back below the 2 per cent target in two years, and keep falling, it predicted.

Mr King was, however, careful to caution that the Bank still saw a danger that inflation could climb yet higher than in its main forecast, and fall less sharply. The rate-setting Monetary Policy Committee faced a “balancing act” between the risk of an even sharper downturn, and even stronger inflation, and would do whatever was needed to hit the inflation target.

There was light at the end of the tunnel, he insisted. “We will come through this,” he said.

Explore Economics

• Pre-Budget Report 2008

• Budget 2009

• World Economic Forum

• The Times MPC

Times Recommends

• Lies and cover-up at MG Rover exposed by report
• High oil prices push manufacturing costs up
• Primark founder steps down as chief executive