The Governor of the Bank of England was thrown on the defensive yesterday after the deepening economic slump forced it drastically to rethink its forecasts for Britain’s prospects.

Mervyn King was forced to deny that he had been “caught with his pants down” by the pace and scale of the country’s slide into a potentially deep and prolonged recession. He was largely unapologetic despite the Bank unveiling the biggest overhaul of its assessment of the economic outlook since it was given independent control of interest rates in 1997.

Mr King insisted that the regime for the Bank to steer the economy was working effectively, and it should not have been expected to act sooner to shore up growth. “I think it’s worked well and I think it will continue to work well,” he said.

Until recent “extraordinary” events, he argued, it had been vital for him and colleagues on the rate-setting Monetary Policy Committee to take account of the dangers of previously soaring inflation. These had imposed conflicting pressures. Yet since the collapse of Lehman Brothers, the US investment bank, in mid-September, and the escalation of the credit crisis, “the world has changed” and this had “transformed the outlook”, he said. The Bank had then responded.

“The facts changed, and the facts justified a big change in Bank rate and we made it,” he said. “I think that is what matters to people – they do not expect people to be able to prevent the world from changing.”

He added: “It is always possible to set policy with the benefit of hind-sight. There is no way in which the committee can have perfect foresight.”

Critics of the Governor’s past handling of the crisis are likely to be inflamed, however, if the economy succumbs to the severe slump that the Bank projected yesterday.

Detractors point out that only three months ago the Bank was predicting only one or two quarters of modest decline in the economy, but its main view now is for GDP to plunge by between 1.5 and 2 per cent next year, in the most vicious slump seen since the depths of the 1980s recession.

Critics also note that David Blanchflower, a dissident member of the MPC, predicted a recession as far back as the spring.

The scale of the change in the Bank’s analysis is emphasised not only by last week’s 1.5 percentage point cut in interest rates to 3 per cent, the lowest for half a century, but also by its indications that it is poised to cut rates further. Mr King conceded that the scaling-back of the Bank’s forecasts for inflation yesterday was the largest in the MPC’s 11-year history.

Economists said the Bank’s expectation that inflation will plunge below 1 per cent by 2010 suggested that interest rates could be cut by another percentage point by Christmas, to 2 per cent, and fall to 1 per cent next year.

Mr King’s detractors will also accuse him of staging a U-turn over the case for a fiscal boost to the economy through tax cuts and public spending increases. Having questioned the value of this three months ago, and suggested it could prove ineffective, yesterday he gave cautious backing to expected fiscal action by the Chancellor this month. Subject to conditions he said it would be “perfectly reasonable in these circumstances to see some fiscal stimulus”.

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