The credit crunch has entered a new and difficult phase but policymakers in Britain still have to balance slowing growth against rising inflation, Bank of England Governor Mervyn King said on today.
Sterling weakened after BoE Monetary Policy Committee members also highlighted downside risks to the pound, which has fallen about 10 per cent on the year on a trade-weighted basis.
"The financial crisis has moved into a new and difficult phase. Across the world, confidence in financial markets is fragile," King said.
Fears have grown in recent weeks that the credit crisis is getting worse and could trigger a sharp downturn in economic growth across the globe.
But giving testimony to parliament's Treasury Committee, King said he expected UK inflation, already running above the central bank's 2 per cent target, to rise even further and hit around 3 percent because of soaring utility bills.
Mr King said it was important that higher inflation did not become entrenched and interest rate policy would have to reflect that risk as well as manage the slowing in the global economy.
"The MPC can have little effect on the short-term path of inflation," he said. "What is crucial is that the pick up proves to be temporary, just as the rise in inflation last year was."
A snap Reuters poll conducted last week found 22 of 56 economists expected the BoE to cut rates by a quarter point to 5 per cent in April, while 34 said it will likely wait until May.
Mr King said the BoE stood ready to provide liquidity to financial markets as needed and was working with the commercial banks to seek a resolution to the crisis.