The Governor of the Bank of England dashed hopes yesterday that it would act to shore up the rapidly weakening economy as he made clear that surging inflation would scupper chances for more than one further interest rate cut this year.

Unveiling the Bank’s bleakest forecast of the economy since Labour came to power a decade ago, Mervyn King delivered a blunt message that soaring food and fuel prices had left it hamstrung over taking more aggressive action to underpin faltering growth.

Bracing the country for a grim two years, the Governor sounded a warning that the economy would flirt with recession as the surge in the cost of energy and food inflicted a severe pinch on households’ spending power and sends consumers into retreat, deepening the downturn already under way.

Mr King’s comments came as fears over the outlook were fuelled by the third consecutive monthly rise in unemployment, which rose by 7,200 last month, on the heels of a 4,200 increase in February and March.

In a gloomy quarterly Inflation Report, the Bank sharply downgraded its view of growth prospects, while steeply increasing its forecasts for inflation.

The Bank now expects that the economy will all but grind to a halt by the autumn, with GDP growing by an average of as little as 0.2 per cent over the rest of the year. It projects that annual growth will hit a low of a meagre 1 per cent early next year, before rebounding to 2.5 per cent by late 2009.

The Governor highlighted brutal rises in living costs. He said: “As those price increases feed through to household bills, they will lead to a squeeze on real take-home pay, which will slow consumer spending and output growth, perhaps sharply.”

Mr King insisted that the Bank did not expect a recession but he conceded that one could not be ruled out. With recession defined as at least two quarters in a row of falling output, he admitted “it is quite possible that at some point we may get an odd quarter or two of negative growth”.

He added: “Clearly, further shocks could push us in that direction.”

In a further blow to homeowners, the Governor also said that already tumbling house prices were likely to fall farther, although he argued that it was impossible to know how far.

Mr King made plain that severe inflationary pressure would rule out any substantial further rate cuts this year.

The Bank’s forecasts showed that if interest rates were cut by another half-point to 4.5 per cent as markets have been betting, inflation would shoot up to almost 4 per cent this year, and would still be above the Bank’s 2 per cent target in two years.

Even with rates on hold at their present 5 per cent, the Bank predicted that inflation would peak at about 3.7 per cent this year before falling back to the target two years ahead of the timescale over which the Monetary Policy Committee strives to hit its goal.

The Inflation Report made clear that the risks were skewed towards an even worse inflation performance, while the dangers to the Bank’s growth forecasts were of a still more dire outcome than on its main view.

Some economists said that rates were now unlikely to fall again this year at all, while others said that at most they would be cut only once more, probably in August.

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