The Bank of England today fueled speculation of further aggressive interest rate rises to come with a hawkish assessment of the outlook for British inflation.
Inflation is currently well below target at just 1.1 per cent , but the Bank said it would move above the official 2 per cent target in two years time even after last week's interest rate rise to 4.25 per cent.
In comments in its quarterly inflation report that sent sterling rising and gilts falling, the bank warned markets might yet have to adjust their interest rate expectations upwards.
Futures markets are pricing in official rates of around 5 per cent by the end of the year and a survey put the consensus forecast at 4.75 per cent .
The Bank warned that even if interest rates rose as much as markets were expecting, inflation would still be "a little above target" in two years time.
"The May Inflation Report is consistent with the idea that the Bank of England still have more work to do in raising interest rates. The market has priced in higher interest rates and this report did not do anything to challenge that," said Mr Adam Chester, Chief Economist at Halifax Bank.
Bank of England Governor Mr Mervyn King said that the situation was fraught with uncertainty.
"How monetary policy will unfold over the next few months, I do not know. Nor, I suggest can anyone else."
Mr King denied last week's interest rate rise meant the central bank was targeting house price inflation but said it played a crucial part in decision making.
"In the Committee's central projection house price inflation slows sharply during the next two years although house prices may well continue to rise strongly in the near term," he told a news conference.
The report said the most significant uncertainty to the bank's central forecast on inflation related to the prospects for house prices and the impact of house price movements on household spending.
It said overall the outlook for GDP growth was stronger than expected in February during the first year of the projection but weaker thereafter.
The change in the growth profile mainly reflected sharper moves in house price inflation, a higher starting value for investment and lower projected growth in the offical measure of public sector output.