Britain is on the brink of recession and faces an extended and painful economic downturn, the Governor of the Bank of England said last night. Mervyn King admitted for the first time that “it now seems likely that the economy is entering a recession”. He told families and business to prepare for a prolonged period of hardship.

“We now face a long, slow haul to restore lending to the real economy, and hence growth of our economy, to more normal conditions,” he said.

A squeeze on take-home pay, soaring living costs and the decline in consumer credit increased the risk of “a sharp and prolonged slowdown”. He said: “Over the past month, the economic news has probably been the worst in such a short period for a very considerable time.”

Mr King said that since the collapse of Lehman Brothers, the US investment bank, on September 15, markets had been hit by an “extraordinary, almost unimaginable sequence of events”. He added: “It is difficult to exaggerate the severity and importance of those events. Not since the beginning of the First World War has our banking system been so close to collapse.”

After months of financial turmoil, Mr King held out hope of an eventual return to economic calm. “The long march back to boredom and stability starts tonight in Leeds,” he told an audience of business leaders in the Yorkshire city. He also boosted hopes of more cuts in interest rates to shore up the economy, with a hint of early moves to follow last week’s emergency half-point reduction.

Inflation dangers had “shifted decisively” in the past month, he said. The threat was now that the slowdown would drive inflation sharply below target, so the Bank would “act promptly to ensure that inflation remains on track”.

With three quarters of lenders failing to pass on the Bank’s half-point cut in interest rates to borrowers, the Governor said that the bank bailout announced this month would take time to restore access to loans.

“It will take time before the recapitalisation leads to a resumption of normal levels of lending,” he said.

But he argued that the rescue of the banks through partial nationalisation, alongside plunging oil prices, should “temper the gloom”. He said: “We are far from the end of the road back to stability, but the plan to recapitalise our banking system will, I believe, come to be seen as the moment in the banking crisis when we turned the corner.” Mr King’s stark message was delivered before official figures, due on Friday, that are expected to show that the economy contracted in the third quarter for the first time since the early 1990s.

A key survey yesterday showed that manufacturers’ confidence has plunged over the past quarter to its lowest in 28 years. Firms now expect the amount of goods they produce to fall to levels last seen in 1980, and have reported plans to slash jobs and investment.

Up to 65,000 manufacturing jobs could be lost by the end of the year, the CBI predicted, as its findings showed industry orders at five-year lows. Separately, HM Revenue & Customs reported that the number of homes sold fell to 59,000 in September from 126,000 a year ago.

The downturn in Britain is likely to be more severe than in other major economies, according to the National Institute of Economic and Social Research. In a report published today the think-tank forecasts that the economy will shrink by 0.9 per cent next year, with future cuts in interest rates failing to make a difference.

Consumer spending will slump by 3.4 per cent – the equivalent of about £450 a year for every Briton – while investment by businesses will tumble.

This means that there is an even chance that the economy will shrink for at least four consecutive quarters, it says.

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