Alistair Darling and Mervyn King yesterday delivered a bleak assessment of economic prospects for 15 years in what the Bank of England governor said was “the most challenging period” since 1997.

Mr King, during his annual Mansion House speech to City grandees, warned households should prepare for the “average take-home pay [to] stagnate this year”, and said that “the squeeze on real income growth is likely to mean that both house prices and consumer spending weaken together”.

In addition to this, the chancellor conceded his Budget forecasts would not be met, accepting that inflation would be higher than predicted and that no country could escape the effects of higher inflation on real incomes and economic growth.

Both Mr Darling and Mr King stressed the need for wage restraint. The chancellor insisted “inflationary pay settlements would undermine rather than raise people’s living standards” and the Bank governor waned that an economic slowdown “will be necessary to dampen price and wage pressures”.

The Shell tanker driver wage dispute is just one example that some companies and employees will do what is best for them rather than for the wider economy. The government insisted that the drivers 14 percent over two years, pay deal was “particular” to the industry, but Mr King issued a warning that he would not allow higher pay deals to result in ingrained inflation.

In a sign that the Bank of England was now thinking about interest rate rises, the governor said: “There should be no doubt that the Monetary Policy Committee is prepared to take whatever action is needed to return inflation to the 2 per cent target and to keep expectations of inflation in the medium term anchored to the target.”

A much tougher statement of intent than he gave in his letter to the chancellor on Tuesday, the minutes of the MPC meeting, published on Wednesday, revealed that the committee had discussed an immediate rise.

The governor made it clear he was not going to go soft on inflation, quite the opposite from his letter earlier this week. He fought back at critics who have called for the inflation target to be changed to ignore current pressures from abroad. “Target growth, not inflation is the cry,” he said. “I could not disagree more.”

“Without a clear guide to the objective of monetary policy, and a credible commitment to meeting it, any rise in inflation might become a self-fulfilling and generalised increase in prices and wages,” Mr King added.

His main message was that if everyone tightened their belts, accepted “a loss of real purchasing power” and understood the Bank could not side-step tough choices in the coming year, things would look up thereafter.