Interest rates in Britain will drop to a new 50-year low in the coming months, economists say, as the Bank of England tries to head off a serious recession. The Bank’s monetary policy committee (MPC) is expected to start the process by cutting rates this week.

The predictions came as Gordon Brown, meeting European leaders in Paris, called for a new £12 billion fund to help small businesses through the crisis. The fund, an early drawing-down of the existing European Investment Bank budget, would “show how we can do more in Britain and across Europe to help small businesses, as well as households, through what is a difficult economic time,” he said.

Lady Vadera, the minister and former Brown adviser, is set to take on a more prominent small-business role under the new business secretary, Peter Mandelson.

Dominique Strauss-Kahn, managing director of the International Monetary Fund, said at the same meeting Europe had to do more to coordinate its response. “What counts above all is coordination and the will not to act each for himself,” he said. “The world economic situation is very worrying,” he added.

On Britain’s interest rates, Global Insight is predicting that Bank rate will drop by a quarter of a point to 4.75% this week with a “real possibility” of a half-point reduction. It says that the rate will fall to 3.25% next year, below the 50-year low of 3.5% reached in 2003.

“The further marked tightening of credit conditions and higher market interest rates that are resulting from the current heightened financial sector problems will be of major concern to the Bank of England,” said Howard Archer, Global Insight’s chief UK economist.

Michael Saunders, Citigroup’s UK economist, said Bank rate could go even lower than 3.25%. “Our base case is for the MPC to cut rates to about 3.25% by late2009, and rates may have to go even lower than that if the vicious circle between the economy and financial conditions continues to worsen,” he said.

The “shadow” MPC, which meets under the auspices of the Institute of Economic Affairs, recommends a cut in Bank rate this week, with four members - Ruth Lea, Patrick Minford, Gordon Pepper and Peter Warburton - calling for a half-point cut.

Three others - Tim Congdon, Kent Matthews and John Greenwood - said the Bank should cut by a quarter. The two remaining members - Peter Spencer and David B Smith - said Bank rate should remain on hold, though one of them, Spencer, said the deteriorating economic news in the days since the shadow MPC vote was taken meant that he now favoured a cut.

Members of the shadow MPC said they were concerned by the impact of recent financial events which, one said, “defy hyperbole”.

“There was a widespread view that the major financial failures of recent weeks, and some easing in the price of oil, had significantly altered the output inflation trade-off facing the authorities,” the shadow MPC’s minutes, to be published today, say. But there was also concern that even aggressive cuts in interest rates may have less impact than in the past. One member likened it to using a peashooter against a tank.

A survey of analysts by Ideaglobal. com, the financial-research company, put a 70% probability on a rate cut this week. The expectation of sharply lower rates came as the government acknowledged the risks facing the economy.

Lord (Digby) Jones, the former CBI director-general, who quit the government at his own request on Friday, said he was increasingly concerned about the impact of the credit crunch on business.

“It’s going to get worse before it gets better,” he said. “To start with the real economy was separated from the financial crisis but it is coming nearer and nearer together.

“There are a lot of good-quality businesses with good products out there and for many of them, if it wasn’t for Asia they’d go bust,” he said. “But if the domestic-based manufacturer doesn’t have the working capital to pay the wages and raw materials pending sales to China, they don’t do anything. That working capital is in short supply.”

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