UK inflation woe 'set to worsen'

Government figures on Tuesday showed that the rate of consumer inflation reached its highest level in 13 months driven by high food and fuel costs.

Mr King said inflation would probably stay above the government target of 2% for two years, hampering the economy.

He added that house prices were set to fall further, though no one could be certain how far they would decline.

Mr King also spoke of the difficult balancing act the Bank had in juggling a slowing economy and accelerating inflation.

"The balancing act faced by the Monetary Policy Committee (MPC) is even more challenging than it was in February," he said as the Bank presented its latest quarterly inflation report.

"The MPC is facing its most difficult challenge yet. For the time being at least, the nice decade is behind us."

Consumer squeeze

Mr King said that external factors, such as high food and fuel prices, and problems in the global financial markets and the subsequent credit crunch, were hitting the UK and would have a noticeable impact on the economy.

"The central projection is for growth to slow sharply in the near term," he said.

The FTSE 100 has fallen back on news that inflation has jumped to 3pc as soaring food and energy prices start to hit real people in the real economy.

At 1030, the benchmark UK index was down 58.1 at 6162.5.

Over the last month, the bulls have been arguing that, with credit markets easing, we should be able to avoid a serious economic crisis.

This shock rise in inflation (most economists had been expecting a figure of 2.6pc) limits the ability of the Bank of England to stimulate the economy by cutting rates further.

"This puts the cat among the pigeons in the U.K.," noted Trevor Williams, chief economist at Lloyds TSB Group Plc and a former government economist. "Interest-rate cuts are totally off the agenda. The underlying problem we face in the real economy is inflation."

In sum, this is the news that the traders simply didn’t want to hear.

Falling prices for gas and electricity, compared with the rises one year ago, was the main reason for the reduction in inflation, the ONS said.

Lower food prices, particularly for vegetables and meat, also helped to keep inflation in check.

However, food prices are still rising at 5%, twice the inflation rate.

The cost of air travel rose sharply compared with falls in the same month a year ago.

The core inflation rate, which excludes food, alcohol, tobacco and energy, was up to 1.9%, compared with 1.8% in April.

Inflation has now been above the government's target for 13 months.