Brace yourselves: Bank of England boss warns of low pay rises and soaring bills in a 'difficult year'

Mervyn King said they should prepare for the lethal cocktail of below-inflation pay rises, rising fuel and food bills and more expensive mortgages. 

In a bleak speech at the Mansion House, a key set piece in the financial calendar, he said Britain is facing 'the most difficult economic challenge for two decades'.

Chancellor Alistair Darling (left), the Lord Mayor of the City of London, Alderman David Lewis, and the Governor of the Bank of England Mervyn King (right) at the Lord Mayor's dinner to the Bankers and Merchants last night

Mr King warned that:
• Average take-home pay will 'stagnate' as family finances are battered by rising fuel, gas, electricity and food prices; 

• Pay rises must remain 'low' to keep spiralling inflation under control; 

• The Bank will take 'whatever action is needed' to return inflation to the Government's target of two per cent, a hint that interest rates could rise; 

• The era of cheap mortgages is over and 'sharp' increases in gas and electricity bills are 'probably on their way'. 

He said: 'It will not be an easy time, and I know that some families will find it particularly difficult.'

In his first Mansion House speech on the same platform, Chancellor Alistair Darling echoed Mr King's warning to workers that big pay rises are a thing of the past.

Chancellor of the Exchequer Alistair Darling at the annual dinner for the Bankers and Merchants of the City of London at Mansion House

The Chancellor said: 'To return now to inflationary pay settlements would undermine rather than raise living standards with a damaging circle of wage increases eroded by steadily rising prices. We must never return to those days.'

He also used his speech to dismiss talk of an imminent recession, insisting that the economy will 'continue to grow.'

But union leaders warned that their members will strike rather than accept a below-inflation pay rise, which is the equivalent of a pay cut.

Action would cause widespread disruption, with key workers across the public sector from the NHS to the civil service threatening to walk out. 

Unison, the public services union, is balloting its 800,000 members in local government, including social workers, teaching assistants and dinner ladies.

It is urging them to reject a 2.45 per cent, one-year pay offer, and to vote to strike

A result is expected on Monday. In a further threat, Unison said it is prepared to rip up an NHS pay deal which was formally agreed yesterday if inflation keeps on rising.

Under the three-year deal worth around eight per cent, 1.3million NHS workers will receive a 2.75 per cent rise this year, far below inflation.

Official figures showed yesterday that inflation has jumped to 3.3 per cent, its highest level since 1992, and is predicted to keep on rising.

The deal was negotiated on the assumption of inflation around three per cent, but the Bank of England predicts it could rise above four per cent within months.

In a speech at the union's annual conference in Bournemouth, general secretary Dave Prentis said it has the right to reopen the pay talks. He said: 'Our members in the NHS have voted to accept a three-year deal. 

'But be in no doubt. There is no blank cheque. I want to make it clear that if prices continue to spiral, we will be back. 

'This agreement will be reopened. 'We won't take no for an answer. If the Government refuses, we will ballot for industrial action. And that's a promise.' 

Yesterday the Public and Commercial Services Union said it is also considering balloting its 280,000 members in the Civil Service about strike action. It threatened a 'varied and imaginative' series of strikes, rather than accept a below-inflation pay rise.

General secretary Mark Serwotka said it is ridiculous to use the 'discredited' argument that public- sector pay fuels inflation. 

'The reality is that we have members earning just above the minimum wage and they see their food and fuel bills and their mortgage going up.'

Brendan Barber, general secretary of the Trades Union Congress, joined the calls for workers not to be punished for rising inflation. 

In a direct warning hours before the Chancellor's speech, he said it is unfair to use workers as a scapegoat. 'Our economic difficulties are caused by reckless lending by bankers and current inflation comes from higher oil, food and commodity prices.'

In a further blow for cash-strapped workers, a Bank report sounded the alarm yesterday about the worsening outlook in the jobs market.

It said more bosses are looking to recruit temporary or freelance workers, rather than commit to the cost of a full-time worker.