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The Bank of England says the UK entered a recession in the middle of 2008 which will continue well into 2009.
In its quarterly inflation report, the Bank warns that the economic landscape has changed dramatically since August.
It now expects inflation to decline to 1% by 2010, below its 2% target, in a dramatic change to its last forecast.
This could open the way for further interest rate cuts if the Bank is to maintain inflation at its target rate in two years' time.
"We are certainly prepared to cut bank rate again if that becomes necessary," said Mervyn King, the Bank of England's governor.
In August, the Bank forecast "broadly flat" economic growth.
Ross Walker of HSBC told the BBC that markets were surprised by how big a fall in inflation the Bank of England had projected, and said he now expected another rate cut in December of at least 0.5%.
"Conditions are going to get worse before they get better," he added.