Costly petrol pumps up inflation rate

Soaring petrol prices forced inflation to a two-year high last month, keeping City analysts guessing over the next move in interest rates.

The annual rate of price increases climbed from 3.1% in May to 3.3% in June, the highest since July 1998, according to the office for national statistics.

The government's preferred measure of inflation, which excludes mortgage interest payments, also increased, from 2% to 2.2%, although it remained below the chancellor's 2.5% target for the 15th month in a row.

ONS officials said the biggest single cause of the acceleration of inflation was dearer petrol, which rose to an average of 84p per litre in June from 80p in May and 70p a year ago, driven by the recent surge in the oil price.

Other significant upward effects came from seasonal food and housing, although there was offsetting downward pressure from the high street, where early summer sales helped to reduce the prices of clothing and footwear.

Overall, core goods prices remained subdued, falling by 2.8% over the year, while service sector inflation rose to 3.5% from 3.4%.

Sterling and interest rates futures were unfazed by the data but analysts split into two camps about the implications for interest rates, pegged at 6% since February.

In the bearish camp, Michael Saunders of Schroder Salomon Smith Barney Citibank warned that the rise in headline inflation, used as a benchmark by wage negotiators, would add to upward pressure on pay.

"Although demand is slowing, it does not seem to be slowing quickly enough to ease capacity strains, especially given the scale of the acceleration in public spending that is likely to be confirmed in next week's comprehensive spending review," Mr Saunders said.

He forecast further increases in interest rates to keep the lid on inflation, with August the hot favourite for the next increase.

However, Philip Shaw at Investec said the figures did not represent a serious threat to the government's 2.5% target for underlying inflation.

While petrol costs would continue to rise in the near term, the prospect of an increase in supply was already driving the price of crude oil down, meaning that by the end of the summer the petrol price and inflation would be falling again.