Interest rates 'may rise to 6%'

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The Bank of England forecast in its quarterly report that inflation was set to return to the Government's 2% target within two years if rates are upped by a further quarter point.

Rates have already risen five times since last August and an increase to 6% would see them reach their highest level since January 2001.

But economists believe that the Bank will be in no immediate hurry to make the increase, given the uncertainties surrounding the country's economy amid heightened volatility in financial markets following the recent floods.

The majority of experts are now predicting a rise to 6% towards the end of the year, revising earlier expectations for a move possibly as early as next month.

Malcolm Barr, UK economist at JP Morgan, said: "A clear tightening bias remains, but without any urgency to act on it in the very near term."

Minutes of the Bank's August rates meeting, when the cost of borrowing was kept on hold, are due out next week and are expected to shed further light on the possible timing of a further rate hike.

In Wednesday's report, Bank governor Mervyn King said rate setters would be keeping a close eye on developments in the stock markets and the impact of the extreme weather on the economy.

He added: "The position at last week's rates meeting was that we'd seen the developments only over the last couple of weeks and couldn't see how they had evolved."

The quarterly report said that the recent heightened volatility in financial markets and the tightening of credit on fears over US sub-prime mortgages, had eased the upside risks to inflation. But it noted that recent high oil prices could put upward pressure on the Consumer Prices Index (CPI), the official measure of inflation.