Employees hoping for pay rises to relieve biting fuel and utility bills received a warning from the Bank of England last night that higher wages would be self-defeating as they would force interest rates up further.

Mervyn King, the Governor, said that the burden of energy prices, higher taxes and pension costs would have to be shouldered by workers in the form of lower growth in wages. If companies tried to raise their prices, the Bank would have to rein back inflation by increasing interest rates.

He said: “All of us — on the shopfloor, in the boardroom or in the public sector — are coming to terms with the fact that those higher costs imply a temporary, but only temporary, slowing in the growth of our real take-home pay.”

His speech to the Birmingham Chamber of Commerce came after the pound rose above $1.99 for the first time in 14 years, as traders bet on the chances of sterling being boosted by more rate rises.

Experts were caught out by the Bank’s surprise decision to raise rates last month to 5.25 per cent, the third increase since August. But a majority of City economists now predict that rates will rise by another quarter-point in February or March, with some forecasting a second rise by the summer.

A report yesterday from the CBI, the business group, that manufacturers were hoping to raise prices at their fastest pace for two years will heighten the Bank’s concerns.

Inflation rose to 4.4 per cent on the retail prices index last month, a 15-year high, and the consumer prices index, the Bank’s target rate of inflation, climbed to 3 per cent.

Mr King’s bluntly worded speech took the form of the open letter of explanation he would have had to write to Gordon Brown had inflation climbed any higher.

The sharp rises in energy prices last year had played a part in driving up inflation, he said, but just as important had been rising asset prices and strong spending levels around the world. Worryingly, that had caused people’s expectations of inflation to drift upwards.

He added that as cost pressures ate into companies’ profits, their temptation had grown to increase prices, rather than take the harder decision to tighten the purse-strings and constrain the growth of employees’ wages. What would happen to interest rates would depend heavily on current pay negotiations, he said.

“If investment and employment growth are to be maintained, the burden of higher costs on employers must either be passed back in the form of lower input costs or forward as higher prices,” he said.

Mr King, whose salary rose below inflation by a fixed 2.5 per cent last year to £283,563, did not single out any sector of the economy, saying that “difficult but inevitable” low pay awards would have to be shared across the board.

However, he also reported that the Bank’s rate-setting Monetary Policy Committee continued to forecast that inflation would fall back in the months ahead — news that could allow a reprieve from the rising path of interest rates.

The CBI said that domestic output prices rose at their fastest rate in ten years over the past three months.

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