Bank of England Governor Mervyn King has kept the door ajar for further money supply-boosting measures after warning that the UK’s economic recovery was still in the balance.

In a gloomy update to MPs, Mr King warned that risks to expectations for the UK economy were “to the downside” and said the Bank could increase its £200 billion quantitative easing (QE) programme if the recovery was to falter.

He told the Treasury select committee that world demand remained “fragile”, while the eurozone recovery “appears to have stalled”, threatening UK exports.

The pound fell in the wake of the meeting, down 0.3 per cent against the euro and 0.5 per cent against the US dollar at one point. This left £1 worth 1.13 euros and 1.54 dollars.

The Governor said it would be a “big help” to the economy if the eurozone economies could return to growth more strongly, but growth is currently seen as “sluggish” by fellow policymaker Charlie Bean.

In the committee’s last inflation report meeting before the general election, Mr King said: “The crisis has left us facing many serious challenges.

“Among them are how to reform the international financial system, how to reduce our largest peace-time fiscal deficit, and how to restructure our banking and financial system to prevent another, more serious, crisis in future.”

Mr King said while the crisis did not originate in the non-financial sectors of society “that is where most of the costs are falling”.

Banks continue to focus on rebuilding their balance sheets and lending to the non-financial sector remains in decline.

He said it was “not a position we are comfortable with”, but there was still “quite a way to go” before the issue is resolved.

Mr King suggested the MPC could extend the QE programme if the economy looked in danger of slipping back into decline.

Inflation jumped to 3.5 per cent in January, triggering a letter of explanation to Chancellor Alistair Darling from the Governor, and it is expected to remain high for a few months before again dropping below the 2 per cent target.

A return to the 17.5 per cent VAT rate, the 70 per cent increase in oil prices over a year and the effects of exchange rate depreciation were all given as causes for the inflationary leap and Mr King today warned that data could be “volatile” in the coming months.

Economists noted the downbeat tone of today’s presentation and forecast that QE could make a return in the future.

JP Morgan’s Malcolm Barr said it was a continuation of the “relatively sombre themes” in this month’s inflation report.

He said more QE “remains very much on the table”, with the decision not to add to the programme last time appearing to have stemmed from reluctance to disappoint market expectations and the issues surrounding the recent spike in inflation.

“Charlie Bean described the recovery in Europe as likely to be ‘sluggish’, and the MPC’s disappointment at the external environment came through more clearly than the inflation report press conference,” he said.

“Mervyn King’s statement that ‘recovery in our largest export market - the euro area - appears to have stalled’ is a rather stronger one than we would make at this stage.”

Howard Archer, of IHS Global Insight, said the testimonies reinforced the view that interest rates would stay at their record low rate throughout 2010 “given likely persistent concerns about the strength and sustainability of the recovery”, while QE could be increased if the economy falters.

He said the Bank appeared concerned that there was a threat to growth prospects “coming from the need of banks, the government and consumers to improve their balance sheets”.

Mr King reiterated the view that the UK was unlikely to see lose its AAA sovereign debt rating, stressing that the country was “very different” from debt-laden Greece with its own currency and longer lead times on its borrowing.

But he said credit agencies were right to pay attention to developments in the UK because of the “very large fiscal deficit” and the current lack of policy on tackling it.

He said clear measures to wrestle the state’s finances into shape should be outlined soon to take effect over the next Parliament, although he added it was “inevitable” that any measures would take time to have any impact.

Meanwhile, external MPC member Kate Barker said she was “surprised” by the strength of the house price recovery and said it was possible the sector could “remain weak” for the rest of this year.

She also warned that banks could be bitten again by woes in the commercial property sector.

Ms Barker said the large number of vacancies in the retail sector could threaten an “after shock” in commercial property in the future.