The pound plunged against the dollar today as global markets took fright over a stark warning by Mervyn King, Governor of the Bank of England, that the UK economy was on the brink of a prolonged recession.

Sterling tumbled to a five-year low against the dollar, to $1.6331, after Mr King said last night: "It now seems likely that the economy is entering a recession." The Governor also told the country to prepare for a prolonged period of hardship.

The euro also fell against the dollar to $1.2743, to its lowest level since November 2006, over expectations that savage interest rate cuts would be needed across Europe to prop up the economy.

While the pound and euro have weakened, the dollar has been gathering strength, after Ben Bernanke, the US Federal Reserve chairman, told Congress on Monday that he endorsed more government spending to stimulate the American economy.

Last night, it also emerged that the Fed could lend as much as $540 billion (£329 billion) in a new facility aimed at restoring liquidity for money market mutual funds.

However, the threat of a global recession sent Asian stocks falling today.

Japan's Nikkei dived by 5.4 per cent to 8,799.61, while Hong Kong's Hang Seng lost nearly 1,000 points in overnight trading as the yen surged against the euro while concern mounted about some of Asia's largest companies and their ability to deliver on profit forecasts.

Mr King said yesterday that a squeeze on take-home pay, soaring living costs and the decline in consumer credit had increased the risk of “a sharp and prolonged slowdown” in Britain.

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.”

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