LONDON, England - January 25, 2011 - Households face the most dramatic squeeze in living standards since the 1920s, the Governor Mervyn King of the Bank of England warned, as he reacted to the shock disclosure that the economy was again shrinking.

Families will see their disposable income eaten up as they “pay the inevitable price” for the financial crisis, said King.

He claimed with wages failing to keep pace with rising inflation, workers’ take-home pay will end the year worth the same as in 2005 - the most prolonged fall in living standards in more than 80 years.

King issued the warning in a speech in Newcastle-upon-Tyne after official figures showed that gross domestic product fell by 0.5% during the final three months last year. The government blamed the unexpected reduction - the first since the third quarter of 2009 - on the freezing weather that paralyzed much of the country last month.

But there were fears that the country was poised to slip back into recession, defined as two successive quarters of negative growth. Economists said the situation was “an absolute disaster”.

The economic gloom deepened this morning as figures showed that mortgage lending by the major banks dived to an 11½ year low during December.

Net lending, which strips out redemptions and repayments, fell to £880 million during the month, the lowest level since June 1999, according to the British Bankers' Association.

Labour has accused ministers of jeopardizing recovery by pushing ahead with public spending cuts too quickly.

King said he was unable to offer any imminent hope of a rise in interest rates in coming months because of the poor economic outlook. He admitted that savers and “those who behaved prudently” would be among the biggest losers in the squeeze.