Rachel Lomax, deputy governor of the Bank of England has said that the economic outlook for 2008 has changed dramatically and that there was still uncertainty resulting from last year's credit crunch.

Speaking at the Institute for Economic affairs, Lomax said that she believed the credit crisis would cause a significant drop in demand in the next two years. She also warned of higher than expected interest rates, higher wages and a sharp increase in inflation.

Lomax warned that the financial crisis could persist and intensify and said that house prices and stock markets could drop, leading to a drop in demand and inflation. However she conceded that the usual economic models could not be used to predict the full impact of the credit crisis.

Lomax gave voice to the Bank's fears about inflation, pointing out that higher utility bills would send the Consumer Price Index up next month.

Lomax said, Its implication for policy depends on whether people recognise the temporary nature of the pick-up in inflation. If price and wage setters start to expect higher inflation to persist, then the committee will need to restrain demand.