Bank of England warns no more rate cuts before 2010 as credit crisis deepens

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Warning: Mervyn King today

However, inflation is predicted to rise far above previous forecasts and stay well above the Government's target of two per cent for up to two years.

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

Saying that "the nice decade is behind us", he added that it was "quite possible we may get the odd quarter or two of negative growth".

Presenting the UK quarterly forecasts, the Bank said inflation could reach 3.7 per cent by the end of the year.

According to the Financial Times, inflation projections will not return to the two per cent target until early 2010, suggesting that the Bank has no room for rate cuts until then - even though the UK economy will slow sharply.

Families face a five-pronged assault on their finances, Mr King said in his bleakest assessment yet of the state of the country.

And the governor predicted:

• Gas, electricity and food bills will get even more expensive this year and will push inflation towards 4 per cent, possibly even higher;

• Economic growth is likely to slump towards 1 per cent by the end of the year, and there is now a risk of recession;

• The housing market will continue to fall after worsening 'markedly', but it is impossible to say how far values will tumble;

• Pay rises may be curbed, further damaging employees' quality of life;

• And the banking crisis could continue to run well into 2009, keeping mortgage costs painfully high.

Mr King's verdict cast a pall over Gordon Brown's political fightback by setting out in grim detail the extent of the difficulties facing the country.

The prospect of soaring inflation and slumping growth will also cast doubt on the Prime Minister's belief that he can pilot the economy to safer waters and avoid a recession.

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Battering: Families have been warned to expect a sharp fall in living standards

Mr King cautioned that there was little scope for the Bank to jump start the economy by lowering interest rates because inflation remained a major threat.

Ominously, he said the economy was rebalancing and the Bank should not try to "prevent that adjustment".

The governor described the problems facing the Bank as "its most difficult challenge yet" since it was given independence in 1997.

In recent weeks, he has called on the Bank of England to follow the Federal Reserve in the United States which has aggressively slashed the cost of borrowing in an effort to jumpstart the American economy.

Mr King said: "We are travelling along a bumpy road as the economy rebalances. Monetary policy shouldn't try to prevent that adjustment."

Jonathan Loynes, of City analysts Capital Economics, said: "The message would seem to be that the Bank's rate-setting committee expects to cut rates only once more at the most.

"Its inability or reluctance to cut rates further now increases the chances that the downturn in the economy will be both deep and prolonged."

The Bank yesterday forecast gas and electricity prices will rise by another 15 per cent this year, another devastating blow for those already struggling to pay average bills of more than £1,000.

This will help propel the Consumer Prices Index measure of inflation to around 3.8 per cent by the end of the year, with a real danger it could exceed 4 per cent.

This inflationary surge will have a major impact on families because it is unlikely pay increases will keep pace.

Chancellor Alistair Darling yesterday admitted he was worried about higher food and oil prices.

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Gloomy: The number of people out of work and claiming benefits has risen again

Higher prices will sap the economy's strength because consumers will not have the money to spend in the high street or elsewhere.

Company costs have also picked up sharply, the Bank warned.

"If companies respond by bearing down on wage growth, then real take-home pay would be very subdued over much of the forecast period," the Inflation Report said.

Economic growth will slump close to just 1 per cent at the end of 2008, a far cry from the 3 per cent of 2007 and below Treasury forecasts.

The Bank is not formally forecasting outright recession - officially defined as two consecutive quarters of falling economic output.

But Mr King issued his bluntest ever warning that this is a real risk.

He said: "You can see there is a sharp slowing of growth, and it is quite possible that at some point we might get a quarter or two of negative growth, but recession is not the central projection."

He added: "Clearly further shocks could push us in that direction."

Mr King warned: "There will be a squeeze on living standards over the next couple of years; consumer spending will not grow rapidly.

"It is going to be a difficult period of adjustment for the country. We need to be patient.

"There is no doubt that the squeeze on real incomes that is coming from the rise in energy prices, food prices, import prices, is affecting spending power right across the economy."

Compounding the danger is the continued crisis in financial markets. While banks have improved their finances, the Bank warned the credit crunch was by no means over.

Bradford & Bingley yesterday became the latest lender to ask investors for extra cash saying it needs around £300million.

Royal Bank of Scotland and Halifax Bank of Scotland have already gone cap in hand to shareholders.

Lenders are not only restricting the supply of loans to over-stretched borrowers, but "somewhat less risky borrowers" are also having trouble getting credit, the Bank warned.

The mortgage drought is having a crippling impact on housebuilders. They say customers are disappearing in droves because they cannot get a loan or they lose their nerve.

Despite the Bank of England cutting interest rates, mortgage rates are still soaring. With a typical loan at £158,000, the cost of keeping up with payments is impossible for many families and there has been a sharp rise in homeowners entering the first stage of repossession.

The Bank said the cost of borrowing would be "even higher" if it had not lowered official rates.

Jobless toll 'will hit 2.3m by the end of 2009'

More than 1,200 people a day will lose their jobs over the next 18 months, economists have warned.

Unemployment has been rising for the last three months and yesterday official figures published by the Office for National Statistics showed that it hit 1.6million in March, up 14,000 since January.

Vicky Redwood, UK economist at Capital Economics, said: "The recent rises are likely to be just the tip of the iceberg.

"The risk of a vicious circle of falling house prices and rising unemployment is growing by the day."

She predicted that by the end of next year unemployment would hit 2.3million, the highest level since 1996 when John Major was still in power.

That would mean an extra 700,000 becoming unemployed - equal to 1,211 every day of the week.

Rising unemployment poses the greatest threat to the economy because of the huge ramifications linked to workers losing their job.

The knock-on effects are almost endless, from falling behind with their mortgage to shoppers deserting the high street and thus causing problems for retailers.

Tory work and pensions spokesman Chris Grayling said: "These figures should give everyone cause for concern.

"With all the economic bad news around at the moment and the mounting cost of living, rising unemployment is just going to make a difficult situation worse."

LibDem spokesman Vince Cable said: "With family budgets being squeezed ever tighter it was inevitable that there would be a knock-on impact on employment.

"The Government must face up to reality and take action now to help restore confidence if we are going to avoid a major economic slump."

One of the biggest worries surrounds house-building.

The Home Builders' Federation warned of "widespread redundancies" in the industry, which employs around 300,000. Thousands more work in "connected" industries, from solicitors to mortgage brokers.

With rising unemployment, the number claiming Jobseeker's Allowance is also starting to go up. It jumped 7,200 in April to 806,300, having been falling for 16 months until March.

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