Britain could take a year to return to normal after plunging into its deepest recession for more than three centuries as the coronavirus pandemic stops households from spending, forces businesses to shut and brings the property market to a crashing halt, the Bank of England has warned.

The economy will sink by as much as 25 per cent in the three months to June – the steepest drop since 1706 – before recovering "relatively rapidly" in the summer and into autumn as social distancing measures are eased, the Bank said.

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A crash on this scale could drag down house prices by as much as 16 per cent, the Bank estimates – plunging thousands of mortgage holders into negative equity.

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The grim scenario would mean GDP falls by 14 per cent this year compared to last year before bouncing back by 15 per cent in 2021, its biggest annual gain since 1704, as the economy returns to something like normal.

It is likely to take as much as a year before shoppers and businesses do return to normal, however, because they are likely to remain cautious even after the formal distancing rules are scrapped.

In its Monetary Policy Report, the Bank said: "Households are likely to maintain some social distancing voluntarily even after official measures are eased. That is consistent with early evidence from countries in which there have been fewer enforced measures and those in which the relaxation of measures is already under way".

"In the scenario, voluntary social distancing is assumed to unwind only gradually over the next year. That is broadly consistent with the experience of Hong Kong following the SARS outbreak."

Officials expect unemployment to jump from 4 per cent to 9 per cent, the highest rate since 1994. It will then gradually fall back to current levels in 2022. This would mean more than three million people are on the dole at peak – on top of the six million workers paid through the taxpayer-funded furlough scheme.

Bank of England Governor Andrew Bailey and his colleagues on the Monetary Policy Committee kept interest rates on hold at 0.1 per cent.

Mr Bailey said: "The Government will decide later this week whether to ease the lockdown, guided by the advice of public health experts. This decision will shape the path by which the economy is brought back into action.

"We expect the recovery of the economy to happen over time, though much more rapidly than the pull back from the global financial crisis.

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"Nonetheless, we expect that the effects on demand in the economy will go on for around a year after the lockdown starts to lift. We expect that there will be some longer-term damage to the capacity of the economy, but in the scenario we judge these effects to be relatively small."

Even this brutal scenario could be too optimistic if the Government insists on social distancing for many months, crippling businesses' ability to operate.

Policymakers said: "The timing of the recovery will depend in large part on how long social distancing and support measures are in place.

"The speed of the recovery will also be affected by how households and businesses respond once measures are lifted," as consumers could continue to practice social distancing even after the formal rules are relaxed, they said.

Under the Bank's assumptions, the economic damage will be even worse if restrictions remain in place longer than expected.

Every extra fortnight of lockdown and support measures in the UK and around the world costs 1.25 per cent of GDP, although this will have little effect on how much output has been recovered in three years' time.

Extra saving by households could also cut growth by one percentage point, while permanently higher unemployment could hit GDP by more than 1 per cent over the longer term if job creation suffers. The Bank's scenario also takes no account of the potential for a second wave of coronavirus infection, which could strike the economy all over again.

Philip Shaw, an economist at Investec, said: "While we are not of the view that the Bank's latest outlook is unrealistic, it does look optimistic.

"Exactly how the economy evolves will depend critically on how the government calibrates its policies and how they are unwound and tapered. There is plenty that could go wrong."

Officials have left room to ease monetary policy further if they see a need to do more to support the economy. Only two of the nine policymakers voted to increase a current round of money-printing from £200bn to £300bn, but economists took this as a sign there may well be more on the way next month.

Kallum Pickering of Berenberg Bank said that he expects another £200bn of asset purchases – where the Bank creates money and pumps it into the economy by buying bonds – by August at the latest.

He said: "Given the current pace of purchases, and the split vote at the May meeting, we may get at least half of that by the June meeting already."

The Bank's financial stability report warned that its main recession scenario left companies short of £140bn in cash due to the lockdown.

It added: "Some businesses will need to access additional sources of finance in order to maintain their productive capacity through the shock."

The Financial Policy Committee (FPC) expects banks to lose £80bn from bad loans during this recession, wiping out almost half of their financial buffers.

Around half of these losses will come from domestic customers, while the rest is made up of overseas loans going unpaid as the pandemic devastates economies across the globe. The Bank expects world GDP to fall by 12 per cent this year.

Of the £41bn expected losses from UK loans, £19bn come from businesses failing to pay what they owe. Another £18bn hit is from consumer credit, for instance on cards and car finance, while the last £4bn us from unpaid mortgages as households' finances are hammered.

Officials have subjected banks to "stress tests" for several years to ensure they are strong enough to survive a serious recession.

The pace of this economic crash is steeper than those hypothetical stresses considered in previous years, but banks are expected to remain strong enough to keep on lending in part because of the expected quick recovery but also because the job retention scheme means millions of workers have been furloughed, retaining most of their incomes instead of losing their jobs.

The Bank added that it is watching for risks when measures to ease the pressure such as mortgage payment holidays come to an end.

Despite the scale of the anticipated losses, the financial policy committee told lenders it is in their collective interest to keep doling out credit as this supports growth, boosts the economy and ultimately results in fewer losses for banks.

Cutting back lending may appear to strengthen banks' positions in the short term, officials said, but would end up starving the economy of credit and so doing more harm than good.

The FPC said: "Continued expansion of bank credit is essential if deeper and longer lasting damage to the economy is to be mitigated. Banks are therefore assumed in the desktop stress test of their resilience to play a key role in helping businesses weather the disruption associated with the outbreak of Covid-19."

It noted that major banks cut business lending by £3bn last year but have already increased it by £20bn so far this year.

- Telegraph