Inflation rise fans rate hike talk

By Sumeet Desai and Matt Falloon

LONDON (Reuters) - The inflation rate unexpectedly rose further above its target in February, boosting expectations the Bank of England will raise interest rates again this year.

Sterling immediately rose three-quarters of a cent and interest rate futures and stocks fell on fears that higher borrowing costs will be needed in the months ahead to tame price pressures in the economy.

The Office for National Statistics said on Tuesday consumer prices rose by 0.4 percent last month, taking the annual inflation rate to 2.8 percent. Analysts had forecast a steady reading of 2.7 percent, already some way above the BoE's 2.0 percent target.

Air fares were to blame for February's acceleration even though fuel costs fell. A lot of this was due to the hike in air passenger duty announced in Chancellor Gordon Brown's pre-budget report in December.

"With Brown widely expected to announce a number of measures to increase tax on polluters in tomorrow's budget, the data comes as a timely warning that voter-friendly environmental policy could contribute to voter-negative monetary policy," said Gavin Redknap, an economist at Standard Chartered.

"Expect the next, and final, hike from the Bank to come by May."

The BoE has already raised interest rates three times since August to rein in inflation and send a tough signal to pay bargainers that it would not tolerate inflationary pay rises.

The RPI inflation measure, on which most wage deals are based, rose to 4.6 percent, the highest since August 1991. So far, however, there has been little evidence wages are soaring.