Last updated 11:38, Monday, 21 April 2008

THE governor of the Bank of England has warned that the UK economy faces its toughest challenges since 1997.

The UK faces “a period of above-target inflation and a marked slowing in growth”, Mervyn King told business leaders. The speech has been described as the gloomiest Mr King has ever given.

He said: “2008 is likely to see higher energy prices, higher food prices and, with a lower exchange rate, higher import prices, pushing inflation above the 2 per cent target.”

He said it was possible that consumer price inflation – measured by the Consumer Price Index (CPI) – would rise to 3 per cent or more.

Mr King also warned that problems in the banking sector relating to huge losses as a result of investments in US sub-prime home loans, meant businesses and consumers would face higher borrowing costs for the foreseeable future. “It is likely that a less buoyant housing market will go hand-in-hand with slower growth of consumer spending,” he said. “Tighter credit conditions mean that, as a nation, we are likely to save more of our income this year than in the recent past.”

“In the short run, that will slow economic activity, possibly quite sharply.

“And there is a risk that weaker activity and lower asset prices could result in another round of losses for banks and a further tightening of credit conditions.”