UK faces recession risk - Blanchflower

By Christina Fincher

EDINBURGH (Reuters) - Britain faces a real risk of recession and house prices could drop by a third unless the Bank of England takes "aggressive" action, policymaker David Blanchflower said on Tuesday.

"Developments in the UK are starting to look eerily similar to those in the United States six months ago. There has been no decoupling of the two economies: contagion is in the air," Blanchflower told an audience in Edinburgh.

A split is growing on the Monetary Policy Committee over interest rate strategy as the economy slows and inflation rises.

Governor Mervyn King has dubbed managing those risks the hardest task since the Bank was made independent in 1997, with hawks such as Andrew Sentance and Timothy Besley raising the rhetoric on inflation and Blanchflower warning on growth.

Blanchflower, the BoE's most dovish policymaker -- he has voted twice for a 50 basis point cut in interest rates this year -- said failing to act swiftly will only mean borrowing costs have to fall further in the long run.

"We face a real risk that the UK may fall into recession, and aggressive action is required to prevent this from occurring. There is a real risk that inflation may undershoot the target in the medium term, and take us into letter-writing territory."

The BoE must write an explanatory letter to government if inflation deviates by more than one percentage point from the 2 percent target. Most policymakers say the most likely outcome is for inflation to overshoot, not undershoot that limit this year.

"The medium term risks to inflation to the downside, arising due to the likely slowing of the economy, outweigh those to the upside," Blanchflower said.