Fears that the Bank of England’s ability to stave off an economic downturn may be hamstrung by persistent inflation increased yesterday as further signs emerged of faltering growth and rising price pressures.

In the latest symptom of weakening economic conditions, a key CBI survey suggested that high street sales dropped in February for the first time in more than a year, while official figures showed business investment spending is falling too. Yet the Bank’s ability to cut interest rates is limited. The CBI’s figures also showed retailers pushing through the steepest price increases for more than a decade.

The threat that the Bank’s Monetary Policy Committee (MPC) may be forced to allow the economy to slow sharply in order to cap inflation pressures was emphasised yesterday by Rachel Lomax, its Deputy Governor.

Ms Lomax highlighted the danger that the MPC will be left with “less scope to respond to slowing demand – the risk posed by the current turmoil in financial markets”. She said that Britain was in the midst of what she called the largest ever peace-time liquidity crisis.

In a speech to the annual conference of the Institute of Economic Affairs, the Deputy Governor said that the Bank had to balance two significant risks: “First, that financial stress will precipitate an unduly sharp slow-down of demand. And second, that temporarily high inflation will lead to inflation expectations persisting at too high a level.” The dilemma facing the MPC was sharpened further by the CBI’s snap-shot of high street activity. The CBI’s main gauge of the proportion of retailers reporting rising sales fell to a February reading of minus 3. This is the first negative result since November 2006, sharply down from January’s figure of plus 4, and far below the long-term average of plus 18.

More than a third of retailers said sales volumes dropped this month, compared with a year ago. Sales in sectors affected by the faltering housing market were worst hit, with the gauge of sales for durable household goods tumbling to minus 70, and that of furniture and carpets dropping to minus 24.

But the CBI also reported that its quarterly barometer of retail groups’ pricing intentions soared to a reading of plus 48 – the highest since November 1996. Economists said a weaker pound and rising import bills could be putting pressure on prices.

The Bank’s quandary was further intensified by yesterday’s disappointing official figures for business investment. Overall investment spending by companies sank by 0.5 per cent in the final quarter of last year, leaving it up by 1.7 per cent from a year earlier.

Investment by construction companies plunged by more than 10 per cent, while in the vital services sector it rose by a meagre 0.1 per cent. In the retail and wholesale industries it dropped by 0.9 per cent. Only manufacturing groups continued to invest, with spending up by 1.6 per cent.

The Bank’s anxieties over the rising expectations of inflation were reinforced by a survey for Citigroup by YouGov, the polling company. The average expected level of inflation over the next 12 months was 3.1 per cent this month, modestly down from the 3.3 per cent last month, itself a record since the YouGov survey began in late 2005.

Explore Economics

• Pre-Budget Report 2008

• Budget 2008

• World Economic Forum

• The Times MPC

Times Recommends

• Lloyds TSB wins vote for HBOS merger
• Bank of England discussed 2% rate cut
• Woolworths dives as it confirms takeover talks