The only way is down; the only questions are how far and how fast.

With recession rapidly tightening its grip on the British and world economies, and the spectre of a dangerous entanglement of Japanese-style deflation looming, members of the Bank of England’s Monetary Policy Committee (MPC) have left no one in much doubt that interest rates have further to fall.

Last month, the MPC stunned the country and wrong-footed much of the City with its surprise decision to deliver a drastic 1.5 percentage-point cut in Bank rate, taking official rates to 3 per cent, a 54-year low.

This week the Bank will deliver another landmark verdict, taking a further step towards, or a leap into, unknown territory as it cuts rates to lows not seen since the 1950s.

The stakes are, undoubtedly, the highest that the MPC has faced since the Bank was given control of rates a decade ago. On the Bank’s decisions now turns the question of how deep and prolonged the recession becomes, whether the economy sinks into deflation and the livelihoods of millions. It is an onerous burden. Here is our monthly guide to the factors that the MPC must weigh up this week.

Growth and activity: slumping

Virtually every gauge of the state of the economy points to it sinking rapidly into a sharp recession and at an accelerating pace. Official GDP figures last week confirmed that the economy shrank by 0.5 per cent in the third quarter – its first contraction since spring 1992 and its steepest since the last recession took hold in 1990.

Still worse, detailed breakdowns of the economy’s plight confirmed suspicions that government spending provided virtually the only continuing source of growth in the past quarter, with every other significant component of demand dragging Britain deeper into the recessionary mire.

A rapid retrenchment by the once-irrepressible British consumer remains the key source of weakness, with consumer spending falling for the second quarter in a row and suffering its sharpest fall since the start of 1995 in the three months to the end of September. Economists expect that a further, headlong retreat by consumers over coming months will continue to sap Britain’s remaining economic strength. Consumer confidence, stuck near record lows, is being eroded by the continuing slump in the housing market, with house prices down by about 14 per cent in the past year. Many market-watchers expect a further fall of 15 to 25 per cent next year.

Corporate Britain is also taking a severe battering and is battening down its hatches. Manufacturing is buckling and suffered a seventh month in a row of tumbling output in September, in its longest run of consecutive declines for 28 years. All the signs are that services activity, too, is crumbling. As a result, business investment is being axed and companies are cutting staff apace.

Unemployment measured by the Labour Force Survey rose by 140,000 in the three months to September to 1.825 million and is set to top two million soon. At 5.8 per cent, the jobless rate is the highest since 2000.

Meanwhile, the lending drought imposed by cash-strapped banks hoarding their funds and fearful of loans going bad is acting like a choke chain on the economy and preventing previous cuts in interest rates having the full impact they have had in the past.

Against all this, the Government has deployed a “fiscal stimulus” of tax cuts and increased short-term public spending worth £20 billion. However, even the Treasury estimates that this will add only 0.5 points to the economy’s growth. This compares with the Bank’s latest central forecast, excluding these fiscal measures, that the economy will shrink next year by as much as 2 per cent.

Costs and prices: tumbling

The MPC’s inflation headache is melting away like spring snow, giving way, with startling speed. to fears of deflation – sustained fall in prices acrosss the economy.

On the Bank’s benchmark consumer prices index, headline inflation plummeted to an annual rate of 4.5 per cent in October, from the previous month’s 16-year high of 5.2 per cent. Crucially for the MPC, “core” inflation, excluding volatile food and energy prices, has also fallen back, to only 1.9 per cent in October.

Public and business expectations of future inflation, a source of anxiety at the Bank, which feared that high inflation would become entrenched if people came to anticipate it, have also collapsed. Last month’s Citigroup/ YouGov survey showed that consumers expect inflation to average only 0.9 per cent over the next 12 months – the lowest level since at least 2005 and down from a record 4.6 per cent as recently as June. Not surprisingly, pay pressures remain extremely muted, with average earnings growth at a headline 3.3 per cent in September, the lowest since July 2003.

Only the pound provides a residual worry over inflation, with sterling’s trade-weighted index down by about 18 per cent over the past year.

International economy: sinking

The news from the rest of the world is no better, with almost every big economy sliding into a synchronised recession and global upheavals across financial markets persisting.

Rates verdict: A deep cut

A half-point cut is a virtual certainty but a more aggressive reduction of up to another percentage point is odds-on, with an outside chance of more.

Bank leaders huddle together in the shelters

Grave and dramatic developments in the economy since September have led to an outbreak of Blitz-style unity on the Monetary Policy Committee, with a consensus emerging that radical action is required.

Mervyn King, the Governor, made clear last week that “We will take whatever action is required to steer the economy back into calmer waters . . . We may need to cut Bank rate more than we otherwise would have done.”

Sir John Gieve, the Governor’s deputy, said: “The immediate priority is to deal with this downswing. The extraordinary measures we have taken are having a positive impact, but we may need to do more.”

Back to the Fifties?

A probable fall in interest rates to 2 per cent this week, or early in the new year, will be a landmark in the Bank of England’s history.

Official interest rates were last this low in November 1951, having fallen to this level in October 1939 and remaining there throughout the early part of the postwar era.

Before this, interest rates also stood at 2 per cent from June 1932 until August 1939. Michael Saunders, of Citigroup, notes that they were also at that level on 19 other occasions since 1694.

In the history of British monetary policy, rates have never fallen below 2 per cent.

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