The government and the Bank of England must take action to avoid lasting damage to the UK economy, the International Monetary Fund said.
The IMF made its comments after the annual review of the British economy.
It said the economic recovery should gain pace later this year but much productive capacity will remain unused for a longer time, increasing the danger that it will be lost.
Britain has not fully recovered from the steep slump caused by the financial crisis, and the economy has fallen back into recession.
The Bank of England has bought a total of £325 billion sterling worth of government bonds with newly created money to boost the faltering economy, but halted the money printing presses earlier this month because of concerns over stubbornly high inflation.
The IMF said threats to the already weak economy were large and an escalation of the euro debt crisis could lead to a self-reinforcing cycle of lower confidence and exports, higher bank funding costs, tighter credit and falling asset prices.
The Bank of England should therefore should ease monetary policy further, either by more asset purchases or by cutting the main interest rate of currently 0.5% further. The UK government should explore additional steps to make more credit available to companies, it added.
The Bank of England could act as an agent to buy private sector bonds or provide longer-term bank funding against a broad range of collateral, the IMF said.
The government should also rejig its spending cuts further towards reducing public employee's wages to fund spending in growth friendly projects such as infrastructure. Should the recovery fail to take off, the government should delay fiscal consolidation, the IMF says.
In a separate report, the Organisation for Economic Cooperation and Development also called Britain's policy mix appropriate, though it warned against a number of risks ahead.
International backing for the tough plan of tax hikes and spending cuts, aimed at erasing a gaping budget deficit, is crucial for finance minister George Osborne as the government has come under attack for the lack of economic growth.
British inflation slides in April
British inflation fell sharply in April, reaching the lowest level for more than two years, official data showed today.
The 12-month inflation rate dropped to 3% last month from 3.5% in March - reaching the lowest level since February 2010 - on lower transport, clothing and food costs, the Office for National Statistics said. Analysts had forecast a slowdown to 3.1%.
The annual drop was helped by a slowdown in airfare rises. April's data covers the Easter holiday period which saw many Britons take holidays abroad.
The consumer prices index rose by 0.6% in April on a month-on-month basis, matching expectations, added the statistics office.
