The Bank of England today raised its inflation forecast slightly, dampening expectations it might pursue an aggressive reduction in interest rates.

In its quarterly Inflation Report, the Bank predicted that inflation would move above its 2 per cent target in two years, reflecting the impact of record oil prices, which have moved above $60 a barrel in recent days.

Three months ago the Bank predicted inflation at exactly 2 per cent at the two-year horizon.

The Bank also reduced slightly its expectations for growth in the near term, reflecting the continued sluggishness of domestic demand.

However, it said it expected growth to move higher in the medium to long term as higher share prices boost consumption and investment.

The Bank said that the latest business surveys and reports from its regional agents suggested that the recent slowdown in the economy may have been less marked than previously thought.

But the report expressed surprise at the extent of the downturn in consumer spending. The Bank said it was possible that the depressed housing market and higher interest rates had had a greater impact than expected.

Economists said this indicated there were still room for another cut in interest rates after last week's reduction by 0.25 per cent to 4.5 per cent but that rates were unlikely to fall markedly in this cycle.

Ross Walker, UK economist at RBS Financial Markets, told Reuters that the report indicated that rates would not fall much further.

"The Bank is quite optimistic that growth is going to recover and take inflation up. The general tone is consistent with what we’ve seen in recent sets of minutes. It’s not particularly dovish.

"We still expect one further rate cut, but all the indications at the moment are that the extent of monetary loosening is going to be fairly modest."

Economists at Lehman Brothers said: "All in all, today's report was a bit more hawkish than we expected, but we are sticking with our call for another rate cut in November on the assumption that near-term growth once again disappoints the Bank's estimates."

Speaking at a press conference after the release of the report, Mervyn King, the governor of the Bank of England, indicated that the uncertainty surrounding the growth and inflation outlook meant that future moves in interest rates were entirely dependent on the data emerging in the coming months.

To illustrate his point he drew a comparison with the performance of the England cricket team.

"As we saw at Edgbaston on Sunday, nothing is that certain. So, as ever, the MPC will play each ball on its merits and not decide in advance where interest rates will go next."

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