Mervyn: interest rates could go to 0 per cent if crisis worsens

“There is nothing in principle against cutting bank rate further if that turns out to be necessary” King told the Commons Treasury Committee. Such a move would cause further pain for savers and pensioners who are already being buffeted by low rates.

The Governor also said he was “pessimistic” about the outlook for the eurozone reports The Evening Standard.

His economic warning came as official figures showed the Government’s deficit reduction strategy is being knocked badly off course by the double-dip recession. According to the Office for National Statistics, public sector net borrowing, excluding the costs of bailing out the banks, was £17.9bn in May, £3.9bn more than in the same month last year.

The rise in borrowing was driven by a 7.3 per cent slump in income tax receipts on the year, reflecting a rapidly weakening economy, and a 7.9 per cent rise in government spending. The sharp deterioration came as an unpleasant surprise to City analysts who had expected public borrowing to fall to £14.8bn.

Chancellor George Osborne has staked his political reputation on making deep cuts to Britain’s deficit by the end of the Parliament and has fiercely resisted calls for a “Plan B”, slowing the pace of cuts to support growth. But the Government’s target of reducing the total deficit to £92bn in the 2012-13 year is now in growing jeopardy.

“Only two months into the fiscal year, it is evident that Mr Osborne is facing a major battle to meet his fiscal targets for 2012-13 and is in grave danger of losing it,” said Howard Archer of IHS Global Insight.

Olann Kerrison, of foreign exchange specialists Moneycorp said: “Plan A, it would appear, is kaput. The spike in public sector borrowing is a body blow to the Chancellor and the Coalition’s handling of the economy.” City forecasters have already begun to raise their estimates of net borrowing over the present financial year.

In a further blow for the Chancellor’s deficit reduction plan, the ONS revised its estimate of total public sector net borrowing in the 2011-12 financial year up from £124.4bn to £127.6bn. The ONS figures showed that Britain’s total public sector net debt rose to £1.013 trillion, equivalent to 65% of GDP.

On Thursday the ONS is due to release its third estimate of GDP in the first quarter of the year and is expected to confirm that output fell by 0.3 per cent over the three months, pushing Britain into its first double dip recession since the 1970s.