Britons should not expect another cut in UK interest rates for at least two years, the Bank of England indicated yesterday as it warned that inflation would rise far above its previous forecasts and persist at levels well above the government’s target until early 2010.

Mervyn King, the Bank governor, said the consequence of price increases would be “a squeeze on real take-home pay, which will slow consumer spending and output growth, perhaps sharply”.

He added that it was “quite possible we may get the odd quarter or two of negative growth”, but added that a recession was not the Bank’s central forecast.

Alistair Darling, chancellor, said his unfunded £2.7bn tax cut would “support the economy when it needs to be supported”.

However, Mr King said the effects of the emergency Budget would be “modest”.

Presenting the latest UK quarterly forecasts, the Bank said inflation was likely to rise above 3 per cent over the next few months and remain more than one percentage point above its 2 per cent target. This, the governor said, would force him to write a “number of open letters to the chancellor over the next year”.

The independent Bank of England is required to explain to the government every three months how it will bring inflation back under control if it deviates by more than one percentage point from the target.

The Bank’s inflation projections do not return to the 2 per cent target until early 2010, suggesting it has no room for rate cuts until then, even though the UK economy will slow sharply.

The Bank’s stance on monetary policy appears similar to that of the European Central Bank.

Mr King contrasted his position – and its focus on controlling inflation – with that of Ben Bernanke of the US Federal Reserve. “We did not fall prey to the sirens to cut interest rates further as some other central banks have done,’’ he said.

In the past three days, markets have moved from expecting two cuts in UK rates to believing there will be none over the next year. Last night, prices in the overnight index swap market showed investors thought a UK rate raise was slightly more likely than a cut.

The blame for higher inflation, Mr King said, lay with surging energy and food prices, along with higher import prices resulting from falls in sterling. The Bank expects another 15 per cent rise in domestic gas and electricity prices in coming months.

Mr King insisted monetary policy should not try to impede a necessary adjustment in the economy, and warned the public to “be patient”.

Malcolm Barr of JPMorgan said the message in the inflation report was clear: “The Monetary Policy Committee believes it has to tolerate a slowdown in growth which is sharp, takes the economy close to stagnation and continues well into 2009 if it is to control inflation risks.”

Although Mr King insisted that a period of very slow growth was needed to help get inflation back to target and stop people beginning to think high inflation rates were normal, some economists believe rate cuts are still likely because the Bank has been over-optimistic on growth.

Jonathan Loynes of Capital Economics said: “We still expect a deeper downturn to mean that interest rates will eventually fall considerably.

The source: http://www.ft.com/cms/s/0/f7095674-21a7-11dd-a50a-000077b07658.html