The Bank of England has predicted the strength of the housing market and economic growth in the UK will push prices higher in the short term. But it hints at a sharp house price slowdown further out.

The prediction comes in the Bank’s quarterly inflation report where housing was marked as being the wild card in the pack. House prices relative to earnings, the impact of house prices on consumption and the nature of any adjustments back to sustainable levels are all “subject to very great uncertainty,” said the Bank.

The report said that at some stage, house prices were likely to rise more slowly than earnings. "As a result, the MPC’s central projection is for house price inflation to slow sharply during the next two years, though house prices may well continue to rise strongly in the near term."

“The central projection is for consumer spending to continue growing strongly in the near term, underpinned by the strength in house prices, but then to ease as disposable income growth moderates and house price inflation slows,” said the report.

Preparing the ground for further interest rate rises, the Bank also said that inflation is expected to climb above 2% in early 2005, hitting levels close to 2.5% by the end of 2006.

At a press conference, Mervyn King the Bank of England’s governor said: "The view that the market has been taking lately, that further increases in interest rates may be necessary, is not an unreasonable one.”

“But I don't know where interest rates are going because that will depend on unfolding events in the future," he added.