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LONDON, March 24 (Reuters) - British businesses should consider official forecasts showing inflation will fall this year when setting their prices, Bank of England Governor Andrew Bailey said on Friday.

"When companies set prices, I understand that they have to reflect the costs that they face," Bailey told the BBC.

"But what I would say, please, is that when we are setting prices in the economy and people are looking forwards, we do expect inflation to come down sharply this year. And I would just say, please bear that in mind," he said.

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Bailey went on to say he did not have any evidence that companies were putting prices up more than necessary.

Britain's central bank raised its main interest rate to 4.25% on Thursday from 4%, a day after official figures showed an unexpected rise in the annual rate of consumer price inflation to 10.4% in February.

Bailey repeated that the central bank expected inflation to fall sharply this year as the impact of last year's steep rise in energy prices fell out of year-on-year price comparisons, and said he was "very relieved" that inflation had stabilised.

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"Now I do see encouraging signs. There is evidence of encouraging progress. But we have to be extremely vigilant on that front," he said.

"And I would say to people who are setting prices, please understand that if we get inflation embedded, interest rates will have to go up further."

Financial markets on Friday priced in one more BoE interest rate rise this year, taking rates to a peak of 4.5%.

Last year Bailey faced criticism from trade unions after he said that attempts to ensure pay growth matched inflation would delay the return of inflation to its 2% target, and shift the costs of higher inflation to those with weaker bargaining power.

On Thursday, BoE staff revised up their short-term forecast for the economy to predict modest growth in the three months to the end of June, rather than a contraction.

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Bailey said Britain's economy now had a good chance of avoiding recession.

"The prospects for the economy in terms of growth are now better, considerably better. And I think it is reasonable to say that there's a pretty strong likelihood that we will avoid a recession this year," he said.

In November the BoE forecast the longest recession since modern records began, though it did say the predicted fall in each quarter was small and a modest upward revision would be enough to break the string of quarter-on-quarter declines.

Reporting by David Milliken and Farouq Suleiman; editing by William James and Angus MacSwan