Sterling was hammered down to a five-year low against the dollar today and the FTSE 100 dropped by almost 200 points as Gordon Brown echoed gloomy comments from Mervyn King and admitted for the first time that the UK is likley to slip into a recession.

The Dow Jones industrial average shed more than 400 points in the first four hours of trading following a slew of bad financial data from major companies including Wachovia, the struggling bank, and drug-maker Merck. Wachovia, which is in the process of being rescued by rival Wells Fargo, reported a quarterly loss of just under $24bn (£14.74bn) today as it took a significant writedown and warned of further exposure to the American mortgage market. At 6.30pm BST the Dow was down 412 points at 8621 - a decline of 4.5%.

The pound began tumbling last night as the Bank of England governor told business leaders in Leeds that the economy is shrinking and hinted at fresh interest rate cuts. The prime minister compounded his comments this afternoon by admitting that the global credit crisis will probably push Britain into a recession.

By 5pm BST sterling had fallen by more than seven cents to $1.6177, a drop of more than 4%, as traders reported frantic selling as investors rushed to cut their losses by selling the UK currency.

Sterling also fell against the euro, slipping to €1.2761 this afternoon. The euro itself fell sharply against other currencies, hitting a four-and-a-half-year low against the yen, and its lowest value against the dollar since November 2006.

In the City, the FTSE 100 shed more than 100 points in early trading and it closed down 188 points at 4040, a 4.5% decline. Mining firms, which will suffer badly from a global downturn, dominated the list of the top fallers.

Traders said the bad news emanating from the US was also depressing stocks across the Atlantic. "We have had a raft of poor earnings figures in the US and the fear continues to accelerate," said Howard Wheeldon, senior strategist at BGC Partners. Ewen Stewart, equity strategist at Investec, said: "The truth is dawning that we are in a pretty long and difficult economic period and there's a realisation that earnings forecasts ... remain too high, and that is driving equity valuations low." Blake Jorgensen, Yahoo's chief financial officer, said on Tuesday that the US economy was entering "what is very clearly a recession mode."

The pound had already been hit yesterday by unexpectedly gloomy manufacturing data showing that confidence has collapsed, and King's comments appear to have added to concern over quite how weak the British economy now is.

Describing the banking system turmoil of recent weeks as "extraordinary, almost unimaginable," he said the financial system had come closer to collapse two weeks ago than at any time in the past 90 years.

"The combination of a squeeze on real take-home pay and a decline in the availability of credit poses the risk of a sharp and prolonged slowdown in domestic demand. Indeed, it now seems likely that the UK economy is entering a recession," King said.

"It is surely probable that the drama of the banking crisis, which is unprecedented in the lifetime of almost all of us, will damage business and consumer confidence more generally."

His fears were confirmed yesterday as the CBI reported that confidence among British manufacturers had tumbled to its lowest since July 1980, with output and orders also collapsing.

The prime minister also conceded for the first time that a recession is likely in the UK. Brown told MPs: "Having taken action on the banking system, we must now take action on the global financial recession." He said this would probably result in "recession in America, France, Italy, Germany, Japan and - because no country can insulate itself from it - Britain too".

The thinktank the National Institute for Economic and Social Research said today that Britain entered a recession in the third quarter of the year and warns the slump will probably last for a year or more, making it every bit as painful as the recessions of the early 1990s or early 1980s.

City commentator David Buik said that King's speech has "put sterling to the sword for the time being".

The Bank of England cut the cost of borrowing by half a point to 4.5% earlier this month, as part of coordinated global action, and King hinted that rates may come down again soon.

"During the past month, the balance of risks to inflation in the medium-term shifted decisively to the downside," he said.

CMC Markets analyst James Hughes said that the possibility of interest rate cuts across Europe have made the greenback more attractive - after months in which traders bet against the dollar.

"Investors continue to flock to the dollar as speculation mounts that central banks elsewhere will continue with aggressive rate cuts in an attempt to stimulate growth in the near term," said Hughes.

Official data out on Friday will almost certainly show that the economy contracted in the July to September period, having not grown at all in the second quarter. A "technical" recession is defined as two consecutive quarters of contraction, which experts say is the least Britain can expect this time round.