US investment bank Lehman Brothers today said there was a 35% chance that the UK could be in a recession within the next two years in a bearish market report.

In its Downward Spiral report it said that by the end of next year house prices are expected to be 8% lower than at their peak in the last quarter of 2007, and warned the Bank of England that it needs to take more aggressive action.

Aggressive rate cuts

Lehman said it expects a 25 basis point cut in the interest rate roughly every three months, with rates bottoming out at 4% in the middle of next year. It said: ‘The Bank of England may need to cut rates aggressively to stop the UK from repeating the recent US experience.’

The bank also significantly revised down its GDP growth forecast for next year from 2% to 1.1% although its 2008 forecast remained unchanged at 1.7%.

It said since the Northern Rock crisis last summer there had been knock-on effects from the financial turmoil to the real economy and policymakers would find it difficult to ring-fence the financial difficulties.