The UK edged closer to recession after official figures showed growth fell to just 0.2 per cent between April and June.
The damage was done by a housebuilding slump as the economy grew at its slowest pace since the beginning of 2005, according to Office for National Statistics (ONS) estimates.
Paul Dales, UK economist at Capital Economics, said the figures fuelled expectations that the UK faces a period of recession - defined by two consecutive quarters of negative growth.
“The economy has weakened dramatically even before the full impact of the credit squeeze and housing downturn has been felt. An outright recession is now our central scenario,” he said.
Business leaders at the British Chambers of Commerce also warned of a “dramatic worsening in economic prospects”.
“The position is likely to deteriorate in the second half of the year. We now expect zero or negative growth in the next two or three quarters,” economic adviser David Kern added.
But the Bank of England is unlikely to come to the rescue with rate cuts in the near future because surging fuel and food costs have pushed inflation to almost double its two per cent target.
One member of its monetary policy committee even voted to raise rates in July to send out a hard-line message on the need to control prices.
Global Insight economist Howard Archer said he expected rates to stay at five per cebt “for several months to come” before cuts early next year.
The fall in the pace of growth, which was in line with City forecasts, underlined the impact of the credit crunch on a struggling housing market.
Construction output fell by 0.7 per cent due to a “particularly large” fall in new housebuilding during the second quarter, the ONS said.
A raft of the UK’s housebuilders have shelved new projects since March as would-be buyers struggle to get mortgages because lenders hit by the credit squeeze have increased borrowing costs.
In recent weeks, builders have axed about 5,000 jobs as the housing market heads downwards.
ING Bank economist James Knightley said recession “seemed probable”. He added: “The credit crunch coupled with falling house prices and rising food and energy costs are continuing to constrain activity, yet fiscal and monetary policy can do nothing to ease the pain.”
The pace of growth was last lower - at 0.1 per cent - seven years ago. The current economic woes threaten a record of 64 consecutive quarters of growth since the UK’s gross domestic product last shrank, between April and June 1992.
The figures come amid predictions of UK growth slowing to its weakest levels since the early 1990s between 2008 and 2010, according to the National Institute of Economic and Social Research (NIESR).
But recent industry surveys have signalled contracting activity in construction, services and manufacturing sectors during June.
The annual rate of growth in gross domestic product has also slowed to 1.6 per cebt - again the lowest for three years, according to today’s ONS estimates.
The quarterly growth performance would have been worse if not for a slight recovery in output from the services sector, which accounts for about 74 per cebt of the economy.
Services firms grew by 0.4 per cent in the second quarter of 2008 - compared with 0.3 per cent in the first three months of the year - driven by progress from transport, communications and storage companies.
This offset output growth of just 0.1 per cent from business services and finance firms - the slowest pace in more than six years - as areas such as financial intermediation and real estate activity weakened.
The ONS estimates also revealed a 0.4 per cent decline in manufacturing output over the quarter. And the squeeze on hard-pressed consumers was highlighted by weaker growth in retail output, which slowed to 0.2 per cent during the second quarter of the year.