His comments came as new figures showed the industry still falling behind its investment targets.
Ian Byatt, the director-general of water services, yesterday warned the privatised water companies that returns on capital would be stripped to "the minimum that investors demand to induce them to invest in the industry".
His comments, at a conference in central London, are the clearest indication yet that the price review he is preparing for 1999 will lead to a sharp one-off reduction in bills for the country's 23 million domestic water users.
Mr Byatt also indicated that water companies in some parts of the country might not be allowed to raise their prices in subsequent years - unlike the present regulatory regime which allows them to pass on the costs of heavy investment programmes to consumers.
"An initial reduction in prices is essential to this review. Otherwise companies would be left with high profits which could lead again to the argument that high profits could finance even more investment, and the complaint that instead of ploughing back profits, the companies had dissipated them."
He was speaking as Ofwat's latest report on capital investment by the water industry revealed that spending in the last two years was 14 per cent below the levels expected.
Although capital investment in 1996/97 was 22 per cent up on the previous year at pounds 3.2bn, a number of companies had not invested the amounts assumed when the current set of price controls were devised.
Although service to customers had continued to improve, the report shows that some companies had not invested sufficiently to improve standards of sewage treatment. Mr Byatt also said he was still concerned about whether dividends being paid to shareholders were sustainable.
"I will be resetting price limits in two years time and this report gives trends and pointers to the way ahead," he added.