Mark Hake, an analyst at Merrill Lynch, says the British housing market could take 20 years to recover from its current downturn.

Merrill, one of the City of London’s leading investment banks, said, in a note to clients, ” … it looks significantly worse [than the 1990 downturn], with house prices falling faster and further and very little recovery in real terms expected over 20 years. … House prices are expected to be below their August 2007 peak in a further 10 years’ time.”

The bank forecasts house prices to fall by as much as 17 per cent this year, while inflation is set to continue its upward march in coming months as the economy absorbs the effects of higher oil and food prices.

To add to the woes, David Kern, economic advisor to the British Chambers of Commerce, thinks unemployment will rise to nearly two million by the end of 2009. He commented, “The results of this survey signal a menacing deterioration in UK prospects We are now facing serious risks of recession. London appears pretty weak and it’s across the board. Businesses are in a lose-lose situation. Falling demand and the squeeze on consumer disposable incomes will limit how far prices can be increased.”

The European Central Bank (ECB) today defied the threat of recession in many eurozone countries and raised interest rates to their highest level for almost seven years, despite frantic political pressure.

ECB President, Jean-Claude Trichet, issued a strong warning on Wednesday that inflation in the zone could explode if left unchecked.

The decision by the ECB’s Governing Council is set against calls to hold firm from European leaders led by President Sarkozy of France. It comes after a leap in eurozone inflation to 4pc in June which set alarm bells ringing over price pressures. This was further fuelled by a rise in factory-gate producer prices within the eurozone, which jumped 1.7pc in May, to stand 7.1pc up on a year earlier. The hike was largely driven by an 18.2pc year-on-year rise in energy costs.

More depressing numbers were released today confirming that the eurozone’s services sector, which is at the heart of its economy, shrank in June for the first time since mid-2003.

Economists pointed out new indications of “stagflation” in the eurozone economy, with output contracting as price pressures continue to build. They believe that today’s interest rate increase is a single-shot for the rest of the year.

Could that be more in hope than expectation though?

Around the world, government and central banks are thinking less about the possibility of deflation and increasing turning their attention to inflation.

But how much do we know about the causes of it, and why are some governments getting it all wrong?

Take the British Chancellor of the Exchequer (Finance Minister), for example. Alistair Darling recently said, “Pay awards in both the public and private sectors have got to be consistent with our inflation target of two per cent.”

It was like going backwards in time to the 1970s when a Labour government literally brought Britain to its knees by exercising almost total control over the economy.

Darling’s reasoning is that if pay rises were higher, prices would go up and consume the value of higher pay.

For a correct analysis of inflation, we have to turn to a former Conservative Health Minister, Enoch Powell, who knew a thing or two about economics. He said, “Of course when there is inflation, prices rise, including wages, which are the price of labour. That is what inflation means; the statement is a mere definition. But it is as absurd to say that inflation occurs because prices rise as to say that it rains because the ground gets wet. You cannot have rainfall without the ground becoming wet; the one is inseparable from the other; but we do not mistake the result for the cause.”

If that isn’t the most concise and accurate explanation, it must come very close.

His alternative to Labour’s prices and incomes policy approach would be to take money out of circulation by the government spending less or the Bank raising interest rates, or a combination of both.

In Britain, growth is at present around 2pc, and is likely to fall to about 1.3pc in the coming year. Inflation, according to government approved figures is about 3.5 per cent. That gives a total of 4.8pc.

Compare that to a rise in money supply (M4) of 12pc and there you have it.

Inflation is caused by having too much money chasing too few goods. And it’s the government that injects that money into circulation, partly by excessive borrowing.

The UK will now have to take money from the economy going into a possible recession — the worst of all possible worlds.