The Bank of England indicated yesterday that Britons should not expect further cuts in interest rates for at least two years. It warned that inflation would rise far above its previous forecasts and continue at levels well above the government’s target until earl 2010.

Bank governor, Mervyn King 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.

Chancellor, Alistair darling 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”.

The bank said inflation was likely to rise above 3 percent over the next few months and would remain more than one percent age point above its 2 percent target.

Every three months the independent bank will have to explain to the government how it will bring inflation back under control if it deviates by more than one percentage point from the target. Even though the UK economy will slow sharply, the banks inflation projections do not return to the 2 percent target until early 2010, which suggests they have no room for cuts until then.

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

Mr King contrasted his position 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.

Over the past three days, the market has moved from expecting to 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 rise was slightly more likely than a cut.

Mr King said the blame for higher inflation lay with surging energy and food prices, along with higher import prices. The bank also expects the price of gas and electricity to rise by a further 15 percent over the coming months.

Malcolm Barr of JPMorgan said: “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.” Believing the message in the inflation report was clear.