Inflation surge sparks talk of rate rise

Britain's annual inflation rate picked up sharply in June, fuelling speculation that the Bank of England will raise interest rates sooner rather than later.

The consumer prices index (CPI) jumped to 2.5% in June, its highest level since Labour came into power in 1997 and matched only once before, in September 2005.

The June figure - up from 2.2% in May - surprised economists, who had pencilled in 2.3%. The pound hit a three-week high against the euro and jumped against the dollar amid expectations that the Bank of England would not wait much longer to raise borrowing costs to bring inflation back to its 2% target.

The Bank's monetary policy committee (MPC) has kept interest rates at 4.5% since August last year. City economists have been divided as to whether the MPC will raise borrowing costs this year or next.

Central banks in the US, Europe and Japan have all raised rates recently to contain inflationary pressures.

The ONS said the greatest upward pressure on inflation came from gas and electricity bills. Power prices have continued to rise for more than a year as big suppliers have implemented tariff increases.

Household energy and water bills rose at their highest rate last month - up 9.8% on an annual basis - since ONS figures began, in 1997.

The ONS warned that price rises in April and May will continue to drive inflation higher in the coming months. High oil prices, which have risen to $78 (£43) a barrel, can be expected to drive forecourt prices to £1 a litre.

The MPC is particularly concerned at so-called second round effects of higher energy prices: Bankspeak for the possible impact on wage claims.

June price rises among foods - mainly vegetables - and non-alcoholic drinks also stoked the inflation rate.

"What is clear is that the Bank of England will be ever more watchful for any signs that second round inflationary effects are increasingly beginning to develop from high oil and energy prices," said Howard Archer of Global Insight.

But Mr Archer noted that core inflation only edged up to 1.2% in June from an 18-month low of 1.1% in May.

HSBC economists also played down today's figures.

"Overall, the headline looks worse than the breakdown," said the bank's European team. "We do not think second round effects will emerge in the UK. The BoE had expected a higher CPI headline reading, and core inflation remains controlled. Hence the release should not worry the BoE at this stage."