Annual inflation accelerated in December at a record pace, prompting worries that interest rates might rise sooner than expected, though the surge was largely due to an unflattering comparison with a year earlier.
Base effects from December 2008's cut in value-added tax, savage pre-Christmas discounting and near-record drop in oil prices accounted for the jump in inflation a year later. Sterling hit a four-month high against the euro and bonds tumbled on the news.
Consumer prices rose at a year-on-year rate of 2.9 percent in December — a nine-month high — and a full percentage point faster than the 1.9 percent recorded in November, the biggest month-to-month jump since records started in January 1997.
Economists had expected a rise to 2.6 percent.
The longer-running retail price index, which includes more housing costs but is not targeted by the Bank of England, rose to 2.4 percent from 0.3 percent, the highest since November 2008 and the biggest monthly increase in the annual rate since 1979.
Gilt and interest rate futures plunged as markets bet the Bank of England may have to start tightening monetary policy sooner than planned, given the speed with which inflation is moving above the BoE's 2 percent target.
"This number must raise questions at the BoE as to why inflation hasn't slowed more in the light of the economic decline," said David Page, economist at Investec.
"The question now is not whether the BoE will do more QE, but when it will start tightening."
Most economists reckon the Bank will hold off adding to its 200 billion pound quantitative easing program next month and make no new purchases of gilts.
Tuesday's data also hardened expectations it may also raise interest rates from a record low of 0.5 percent sooner rather than later.
The Bank of England had already flagged up a temporary hike in inflation but nonetheless forecast that it would fall back to 2 percent by mid-2010 as weakness in the economy prevents firms from raising prices.
However, analysts said the scale of December's pick-up put this in doubt.
George Buckley, UK economist at Deutsche Bank, estimated that based on Tuesday's data, inflation would exceed 3.5 percent next month and remain above 3 percent until the second half of the year even if the rate of monthly price changes falls back to its five-year average.
Economists will be closely watching a speech by Bank Governor Mervyn King at 7 p.m. for clues on whether the central bank thinks the new data markedly shifts the medium-term outlook for inflation.
"The pick-up in market inflation expectations will be a little concerning and with activity data set to come in on the firm side later this week, comments from BoE Governor King in a speech tonight will also be closely followed," said James Knightley at ING.
Broad-based year-on-year price rises affecting 10 out of 12 retail sub-sectors, led by transport and clothing and footwear costs, were to blame for December's rise in inflation, the Office for National Statistics said.
Core CPI, which excludes food, energy, tobacco and alcohol, rose by 2.8 percent on the year — its fastest pace of growth since records began in January 1997.
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