The governor of the Bank of England has warned that large wage rises and price-setting to reflect surging inflation risk embedding rising costs in the economy, resulting in “slow activity and increased unemployment”.

Andrew Bailey told the Treasury committee of MPs that the so-called second round effects of the energy-led rise in living costs were his “biggest concern” and, if realised, would hurt the least well-off the most and could lead to even higher interest rates.

The Bank used the publication of its Monetary Policy Report earlier this month to declare that the fastest slump in living standards on record was on the way.

The rate of inflation, already at its highest level for almost 30 years at 5.5%, is tipped by the Bank to hit 7.25% in April when the energy price cap is lifted by an average of almost £700 to account for unprecedented increases in wholesale gas costs.

The Bank, which cannot control external price shocks, has raised the base rate of interest twice in a bid to counter early evidence that wage growth was picking up fast and risked fuelling the inflation problem.

Mr Bailey, who had urged pay restraint earlier this month, clarified that he was not saying people should not get pay rises.

He told the committee he wanted to avoid big wage increases that contributed to further inflationary pressures.

The governor made his remarks after chancellor Rishi Sunak told Sky News it was not his business to dictate what private companies awarded their staff.

Mr Bailey told MPs: “It’s not just wage setting, it’s also price setting … it’s both.

“There is very clearly an upside risk there. The upside risk … comes through from the second-round effects.”

He agreed those included corporate margins, basic pay, executive pay and bonus levels and added: “It’s a very harsh message”.

But he admitted “I can’t dictate how people go about this, of course I can’t”. “Please reflect on the economic situation we’re in with this big economic shock coming.”

“The least well-off will come off worse in this process if we don’t have… restraint”, he concluded.