The Bank of England made clear today that another interest rate rise looked very likely despite yesterday’s drop in headline inflation.

Presenting the Bank’s quarterly Inflation Report, Mervyn King, the Bank’s Governor, said that the main risks that could force rates to rise again came from higher inflation expectations and businesses becoming increasingly confident of their ability to raise prices.

The report showed that inflation would stay on track in two years’ time only if market expectations of another rate rise this summer are fulfilled by the Bank’s Monetary Policy Committee.

However, he said, “the main downside risk is that there could be more slack in the labour market which would slow pay growth further.”

Data published separately today suggested that the labour market was becoming looser. Unemployment climbed by 13,000 over the three months to March to hit 1.7 million, according to the Office for National Statistics’s survey-based measure.

The ONS added that headline average earnings growth fell in March to 4.5 per cent from 4.6 per cent the previous month.

Mr King said that inflation would fall this summer as gas and electricity bills fall compared to last year’s rises.

But the “crucial question” for monetary policy was where inflation was likely to be once energy prices have settled down, he said.

“At that point inflation will reflect the balance between money spending and supply capacity in the economy as a whole,” he said.

He downplayed differences of view on the MPC, which have seen one member, David Blanchflower, voting for a cut recently.

“There are differences of views, I don’t think they’re particularly large at this point, but there are differences,” he said.

Mr King also said that there was “not much point in fretting” about the value of the pound and, as usual, gave no forecast of whether sterling’s strength against the dollar would continue.

The Bank said that it expected GDP to rise at about its long-run average of between 2.7 and 2.8 per cent over the coming two years, in line with its previous forecast.

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