Firms faced their worst cashflow situation in the second quarter since comparable records began in 1992 as sales in the domestic market fell, but price pressures remained very strong, a survey showed yesterday.

The British Chambers of Commerce survey of nearly 5,000 businesses highlighted the dilemma facing the Bank of England as economic growth is slowing but inflation is rising. No change in interest rates is expected when Bank policymakers meet this week.

The BCC reported a sharp deterioration in conditions over the past three months. This was particularly evident in the service sector where confidence, hiring intentions, sales and orders all fell to their lowest level since the early 1990s.

"These results show a real risk of recession in the coming months," said David Frost, director general of the BCC.

Mr Frost said the British economy was likely to grow 1.25 per cent this year as a whole, but two quarters of contraction - the technical definition of recession - was a possibility.

Sterling's weakness, however, was having a beneficial effect on exports which were holding up well, the survey showed.

"But one has to ask the question how long this can persist; a slowing world economy could well put the brakes on UK export business going forward," said George Buckley, chief UK economist at Deutsche Bank.

The BCC report intensified pressure on the pound and gave support to bonds as investors bet that economic weakness will mean that the Bank will be able to hold off from raising interest rates despite high inflation.

In the survey the manufacturing domestic sales balance fell to -3, its weakest level since the fourth quarter of 2001, from +12 in the first. Sales and orders for exporters, however, rose.

The balance of manufacturers under pressure to raise prices hitting a new all-time high. In the service sector, the balance of firms expecting to raise prices fell two points to +41, still at an uncomfortably high level. Cashflow balances for both the services and manufacturing sector fell to their lowest level since the series began in 1992. The BCC said there was no sign yet that banks were turning off the funding taps but lending terms had been tightened up.

The economy grew 0.3 per cent in the first quarter and the National Institute of Economic and Social Research estimated it expanded by another 0.2 per cent in the second quarter.