LONDON (AP) - A few months ago, the British economy was sailing full steam ahead.

Foreign funds flowed in, investment bankers pocketed record bonuses and ordinary Britons used soaring property prices to fund luxury spending. London was being touted as a serious rival to New York as the world's financial capital.

Then the global credit crunch hit. Commercial and private property prices began sinking and lay-offs have started in the financial sector.

The credit squeeze originated in the US after the wave of sub-prime mortgage defaults, but is taking a heavy toll on Britain Inc. With its manufacturing sector a faded remnant of its storied past, Britain has staked its future on its massive financial services sector - which is exactly where the crisis is.

Financial services accounts for more than one-fifth of all British jobs, compared with just six percent in the US, and contributed around a quarter of the nation's growth over the past five years.

In the US, other sectors have stepped up as financial markets wobble. Exporters of high-value manufactured goods such as Germany, for example, are enjoying particularly healthy trading.

The British government, in contrast, has been criticised for not investing enough in science and industry - while pouring billions into collapsed mortgage bank Northern Rock - and the chances of a major manufacturing revival are slim. Many of Britain's former manufacturing jobs moved to lower-cost destinations long ago.

While Treasury chief Alistair Darling has insisted that Britain has "good reasons to be confident" about its ability to withstand a slowdown in the global economy, others are not so sure.

As the Bank of England scrambles to outpace the effects of the credit squeeze by slashing interest rates to spur confidence, the credibility of the government of Prime Minister Gordon Brown - the former Treasury chief who took over from Tony Blair last year - is being put into question.

Richard Lambert, director general of the Confederation of British Industry, believes the reputation of Britain as a leading financial centre has been tarnished. He said a run on deposits at Northern Rock plc. made the country look like a "banana republic."

Britain's strong growth over the past 15 years depended almost entirely on three sectors: finance, housing and the government spending.

But the success of the first two left Britain extremely exposed to financial market turmoil.

With the global credit squeeze already threatening that investment, experts say the situation is being made worse by the government's planned crackdown on wealthy foreigners who currently live in Britain but do not have a British domicile for tax purposes.

There are fears that the foreign money that has sustained the capital's market in recent years will flow out of Britain after changes to close current tax loopholes scheduled to take effect in April.

"We shall be less likely to attract the current high levels of US investment to the UK," warned Peter Hunt, the managing director of BritishAmerican Business, which has 3,000 member companies.

Even Digby Jones, Brown's new trade minister - and former head of the Confederation of British Industry - has broken government ranks to criticise the changes that will charge so-called non-domiciles more tax.

"It has caused people to say 'Does this mean you don't want us?"' he said, adding that on recent trips to India and the Gulf he has been frequently asked about the tax changes.

There were some signs this week that Mr. Darling might back down on the plans after vocal criticism from Indian-born tycoons Swraj Paul and Gulam Noon - both financial supporters of the ruling Labour government.

Meanwhile, in the City, London's financial quarter, banks are curbing growth plans after sustaining losses of more than $100 billion (70 billion euros) because of mortgage investments.

And a lower bonus might be the least of many investment bankers' worries.

"We may be looking at 8,000 job losses in London's financial sector," said Jonathan Said, an economist at the Centre for Economics and Business Research.

Investment bank Morgan Stanley announced yesterday that it will shutter its UK business that issues home loans and scale back mortgage operations in the US, leading to the loss of 1,000 jobs. It was not immediately clear how many of those would be in Britain.

The clouds over the financial sector are reflected in the slump in the commercial property market. In the final quarter of the year, companies leased the smallest amount of space in central London in almost three years, according to real estate company CB Richard Ellis Inc.

Residential property prices are also on a downward slide, with economists' predictions for this year ranging from flat growth to declines of up to 10 percent after a decade-long boom.

That could spell particularly bad news given that Britain's housing and mortgage growth over the past 10 years has been stronger than that in the US. Mortgage borrowing at the beginning of 2007 was 125 percent of disposable income, compared with 103 percent in the US house prices have risen over the past decade by 85 percent, compared with just 60 percent in America.

That means that many Britons who borrowed off their mortgages during the boom times to finance vacations and buy luxury goods are now tightening their belts.

The Bank of England has tried to counter the slowing growth with two interest rate cuts in the past three months, bringing the official borrowing rate down to 5.25 percent.

But many analysts say that the central bank's action may not be in time to halt a downturn.