The Bank of England warned on Wednesday that inflation could reach 5.0 percent this year because of soaring domestic energy costs, high oil prices and the government's sales tax rise.
In a quarterly report, the central bank also lowered its forecast for British economic growth for the next two years, citing the impact of state austerity measures and stretched household budgets.
"There is a good chance that inflation will reach 5.0 percent later this year and it is more likely than not to remain above the 2.0-percent target throughout 2012, boosted by the increase in (sales tax) VAT, higher energy and import prices, and some rebuilding of companies' margins," the BoE said.
"The projection over that period is markedly higher than in February, mainly reflecting the recent increases in energy prices, including the likelihood that they will lead to higher utility bills."
The BoE, which held interest rates at a record low 0.50 percent last week as it balanced high inflation with tepid economic growth, is tasked with keeping annual inflation close to a 2.0-percent target.
"Inflation is likely to fall back through 2012 and into 2013 as the temporary impact of those factors raising inflation wanes and some downward pressure from spare capacity persists," it added on Wednesday.
The news sparked speculation that the BoE could raise borrowing costs later this year to try and keep a lid on inflation.
"The report suggests that, in the bank's view, the market has perhaps gone a little too far in not expecting an interest rate rise this year," said ING economist James Knightley.
He added: "The market had been expecting the first rate hike to come in January next year, but following these details they are now anticipating it will be December and sterling has responded positively."
The BoE also predicted that gross domestic product (GDP) would grow by approximately 1.7 percent this year, compared with the previous forecast of 2.0 percent that was given in February.
And in a further blow, the central bank downgraded its 2012 growth forecast to around 2.2 percent, from just under 3.0 percent previously.
The economy flatlined over the past six months, recent official data showed, amid the impact of deep government spending cuts and tax hikes.
Gross domestic product grew 0.5 percent during the first three months of 2011. But GDP had slumped unexpectedly by 0.5 percent in the final quarter of last year, leaving growth broadly unchanged over six months.
The BoE added on Wednesday that the "pace of the recovery was more likely than not to pick up from its recent soft patch".