BoE may hike interest rates

British inflation is at a multi-year high and workers expect no let-up in price pressures, so investors are betting the Bank of England may have to hike interest rates again to head off inflationary wage deals.

The Bank of England has lifted borrowing costs twice in the last four months as inflation has drifted further above its two per cent target, but policymakers may have to step harder on the brake to bring prices back under control.

According to the Bank's own survey, people's expectations of future inflation accelerated in November to match a six-year high of 2.7 per cent.

Consumer price inflation also hit 2.7 per cent in November - its highest since records began nearly a decade ago - while the price gauge on which most pay deals are based is running at an eight-year high, just shy of four per cent.

And data showed retailers continued to put up their prices in November after many years of discounting.

The figures must provide uncomfortable reading for policymakers, who are hoping that workers will help prevent an inflationary spiral by settling for modest pay rises in 2007.

Financial markets are already gearing up for a hike early next year, with interest rate futures now fully pricing in a quarter point rise to 5.25 per cent by the summer compared with little more than a 50/50 chance seen two weeks ago.

"The hawks got further ammunition for an additional rate hike," said James Knightley, economist at ING. "This runs the risk of putting additional upward pressure on wage demands, which if this materialises in higher average earnings growth, will help to ensure a February interest rate rise."

The Bank of England says it expects inflation to fall sharply next year as energy prices ease. But policymakers are keeping a close eye on wage deals in the crucial New Year pay round, worried that workers will demand higher wages to compensate for huge rises in their household bills this year and further propel inflation.