(Adds British finance ministry reaction, detail)
By David Milliken and Sumeet Desai
LONDON, May 20 (Reuters) - Britain's recession is easing but any recovery is likely to be subdued because of high levels of household debt and a possible shortage of bank credit, the International Monetary Fund said on Wednesday.
The IMF also said it was crucial Britain continued a strong commitment to medium-term fiscal consolidation as the financial crisis was creating a very big budget deficit.
"The economic recovery is expected to be subdued and gradual as banks and households go through a difficult balance sheet restructuring process," the IMF said in its annual health check for the British economy.
"Faced with falling house prices, significant reductions in the value of pensions ... a deteriorating and uncertain employment outlook, and reduced access to credit, consumers are likely to retrench spending to reduce debt and rebuild savings."
Nonetheless, there were signs that economic confidence was improving and government action had succeeded in containing the crisis and avoiding financial meltdown, the IMF said.
Britain said it was taking the IMF's views on board.
"We note the IMF's assessment of the scale of the challenges ahead and their advice," the Treasury said. "Restoring the flow of credit to the economy will be crucial to building and supporting the recovery."
The IMF said in April that it expected Britain's economy to shrink by 4.1 percent this year, a sharper decline than the 3.25-3.75 percent contraction forecast by the Treasury in finance minister Alistair Darling's annual Budget.
The IMF said Britain was not in a strong position if the global economy took an unexpected turn for the worse.
"The sharp increase in public sector borrowing and contingent government liabilities, together with continued financial sector fragility, are significant vulnerabilities," it said.
Britain plans to issue a record amount of public debt this year and next as it faces what economists expect to be the worst year for its economy in 60 years.
As well as purchasing government debt as part of its 125 billion pound ($193.5 billion) quantitative easing policy, the IMF said the Bank of England should be more active in buying private-sector assets to try to jump-start stalled markets.
"We support, in particular, targeted efforts to reduce excessive risk premia in private credit markets that are currently dysfunctional but deemed to be viable in the long term," it said.
"At a more fundamental level, the public's confidence in the Bank of England's operational independence remains contingent on the stability of public finances. This puts a premium on a path of fiscal policy that restores sustainability," the IMF added. (Reporting by David Milliken and Sumeet Desai; Editing by Victoria Main) ($1 = 0.6459 pounds)