It could cause a 1.5pc contraction of the UK economy, a 25pc fall in house prices and a 35pc drop in commercial property prices over three years, according to the scenarios mapped out by the Bank. Other major countries would suffer similar effects, it says.

It also indicates that the risks of a serious financial problem in the City have increased during the past six months, and investors would be wrong to assume that, following the market turbulence of past months, the worst is now over.

Although it said the financial system remained extremely healthy, there were six major risks that could, in certain circumstances, lead to serious financial trouble. To a large extent, these risks revolve around the record level of debt that has been built up in recent years by UK households and businesses.

It said a combination of these risks could create a serious crash if, for example, there were a sharp turn in the credit cycle, caused by higher interest rates.

"The severe crystallisation of credit, market and liquidity risk could plainly represent a serious shock to the UK financial system," it says.

"Such extreme scenarios could be sufficient to more than absorb the annual profits of the UK banking system and therefore cause some material erosion of capital.

"Although such an outcome is very unlikely, given its potential impact, it merits consideration in financial firms' risk management planning."

The doomsday scenario was painted in the Bank's Financial Stability Review, a study about how the City would react if struck by a crisis.

The vulnerability of banks to a collapse in the debt bubble is illustrated by the recent rapid rise in their funding gap (see chart), which shows that in recent years the amount lent to customers that is not backed by customer deposits has soared. Banks are, therefore, having to rely much more on the wholesale money market, which tends to be far more expensive than customer deposits.

The Bank of England is also increasingly concerned about the complex and risky financial instruments devised by banks and hedge funds, of which little is known.

The Bank is believed to feel that many institutions using these instruments, such as credit derivatives, are "sitting with their fingers crossed, hoping that the music doesn't stop".

Another serious worry is the possibility of a global pandemic of a human form of avian flu, and the Bank will conduct a computer simulation later this year of how the City would be affected if the disease broke out in London.

President Bush's critics say the swelling trade deficits, which they blame on unfair trade practices in countries such as China, have contributed to the loss of nearly 3 million manufacturing jobs since Bush took office.

The increase in the May deficit reflected a 16.9 percent jump in America's foreign oil bill, which totaled $27.9 billion, up $4 billion from April. The increase reflected a big jump in the average price of imported crude oil which rose to $61.74 per barrel, an increase of $4.92 from April. That was the biggest monthly jump since a $6.06 increase from August to September 1990 after Iraq's invasion of Kuwait sent global oil prices soaring.

Economists are predicting that the trade deficit will worsen further in coming months, reflecting further increases in world oil prices, which hit a new record above $75 per barrel last month.

The politically sensitive deficit with China rose by 4 percent to $17.7 billion, reflecting big gains in imports of cell phones, clothing and textiles and writing and art supplies.

Both U.S. exports to other countries and imports set records in May.

Exports rose a sharp 2.4 percent, the biggest monthly gain in 17 months. The increase pushed total exports to $118.7 billion as overseas sales of American farm goods, industrial supplies and consumer goods climbed to all-time highs.

Imports, driven higher by the surging oil prices, rose 1.8 percent to a record $182.5 billion.

The U.S. deficit with Mexico rose to a record of $5.5 billion but the deficit with Canada, America's other partner in the North American Free Trade Agreement, declined slightly to $5.8 billion.

The deficit with the 25-nation European Union rose to $10.8 billion while the imbalance with Japan edged down slightly to $7.1 billion.

The administration is facing increasing pressure in an election year to show progress in dealing with the deficit. New Treasury Secretary Henry Paulson has said he will continue to pursue efforts to get China to overhaul its currency system to allow the yuan to rise in value against the dollar.

American manufacturers contend the yuan is undervalued by as much as 40 percent against the dollar. That makes Chinese products cheaper for American consumers and makes American goods more expensive in China.