The Bank of England yesterday downgraded its growth forecast for the UK and braced households for an interest rate hike as early as the spring.
The bank said in its latest forecast that growth in 2011 will be weaker than previously estimated but reassured that a double-dip recession was unlikely as growth is set to resume following the shock contraction at the end of 2010.
Its quarterly report confirmed inflation is expected to soar close to five per cent before falling to around the two per cent target in 2012 - but only if interest rates rise in line with market expectations from the second quarter of this year.
The market expects rates to reach one per cent by the end of the year and the report warned that if the bank took no action (holding rates at an historic low of 0.5 per cent) inflation would still be above target in two years’ time.
But the bank said that, even if rates rise in line with market expectations, inflation will remain “well above” target for the next year and there are doubts over the timing and how far it will drop back.
Following the publication of the report, Governor Mervyn King said the bank’s monetary policy committee believes inflation will fall back next year but added “the extent to which it will do so is uncertain”.