Britain’s banking chief, Mervyn King, has delivered the strongest warning yet that families across the country will see their living standards and value of their homes fall this year.

The Bank of England Governor also warned that there will be a guaranteed kickback for big inflationary pay rises in the form of higher interest rates – and dearer mortgages. He said the Bank’s monetary policy committee would take “whatever action is needed” to return the official rate of inflation to the Government’s target of two per cent – half the level the Governor is forecasting.

In a gloomy speech to City chiefs in London last night, Mr King said Britain was facing “the most difficult economic challenge for two decades”.

He said average take-home pay would “stagnate” as household incomes cope with soaring costs for fuel, gas, electricity and food.

Mr King, who was educated at Wolverhampton Grammar School, also said the era of cheap borrowing for mortgages was over.

His toughest message was about inflation following the increase to 3.3 per cent in the official rates and his own forecast that it would top four per cent by the end of the year.

“The rise in commodity prices cannot, by itself, generate sustained inflation in the United Kingdom unless we allow it to. We will not,” said Mr King.

“So although inflation in the UK will rise in the short term, inflation will then fall back. That means that the rate of increase of other prices and domestic costs, notably pay, must remain low. It will not be an easy time, and I know that some families will find it particularly difficult.”