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UK inflation jumped to an 11-year high of 3% in December, raising the prospect of more interest rate increases.Official figures showed that higher fuel costs helped to push the Consumer Prices Index up from 2.7% in November.

An increase had been expected following last week’s shock rise in UK interest rates to 5.25%, but the rise was larger than analysts had forecast.

Prime Minister Tony Blair said higher oil prices had driven inflation, and forecast CPI would fall to 2% in 2007.

“The underlying position of the British economy, even with the recent interest rate rise, is one of strong economic growth, historically very low interest rates, inflation under control and employment and living standards high,” Tony Blair said at his monthly press conference.

The Retail Prices Index, which includes mortgage interest payments, rose to 4.4% in December from 3.9% thats a 0.5% increase.

The RPI figure – which is often used as a basis for wage demands – is now at its highest level since 1991.

Reaction

“Now we know why the Bank of England raised interest rates last week,” said Howard Archer, chief UK economist at Global Insight.

‘There remains the real risk that the Bank of England will hike rates again ‘

“This is a pretty unhealthy report all round for the Bank of England to digest, fully justifying the immediate hike in interest rates.”

Analysts said there is now strong chance of further interest rate rises.

“Given evidence suggesting that wage rises are picking up, there remains the real risk that the Bank of England will hike rates again,” said James Knightley, an economist at ING Bank.

“We would expect any move to come in the next two months.”

Meanwhile Investec economist Philip Shaw predicted the Bank would add another 0.25 point rise – “possibly as early as next month”.

Petrol costs

The Office for National Statistics said the largest upward impact on prices in December came from transport costs.

These were lifted by rising petrol prices and the fuel duty increase unveiled by Gordon Brown in the pre-Budget report.

‘The higher gas bill has been the hardest thing to deal with in the last year ‘

The Bank of England is tasked with keeping CPI inflation at the government’s target rate of 2%, but it has now exceeded this level for eight months in a row.

If CPI inflation should rise above 3.1%, the Bank’s governor Mervyn King would have to write a letter of explanation to the government – the first time since the Bank gained independence in 1997.

“Given that the CPI is generally a lagging indicator, we can expect inflation in the UK to climb further in the short term, taking us well above the Bank’s 2% target,” said Martin Slaney, of GFT Global Markets.

“Although Bank of England governor Mervyn King will not be obliged to write that `Dear Chancellor’ letter just yet, his pen will be poised.”