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Pressure mounts on Bank of England to raise rates as inflation shows unexpectedly big rise

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LONDON - The British pound spiked near a six-year high against the dollar Tuesday after a surprisingly big increase in U.K. inflation fueled expectations that the Bank of England may start raising interest rates soon, possibly by the end of the year.

Figures Tuesday from the Office for National Statistics showed consumer prices rose by an annual rate of 1.9 per cent in June, just below the Bank's ostensible target of 2 per cent. Inflation, which rose from May's 4 1/2-year low of 1.5 per cent, is now at its highest level since January.

The consensus in the markets was for a far more modest increase of 1.6 per cent rise. The forecast-busting figures gave the British pound a further boost to $1.7192 at one stage, its highest level since October 2008 when the global financial crisis was in full swing. It then settled back to trade 0.4 per cent higher on the day at $1.7151.

With the U.K. economy growing faster than most other developed economies, the pressure is mounting on the Bank of England to start increasing interest rates, especially if inflationary pressures are starting to build. The bank's main rate has been at an all-time low of 0.5 per cent since March 2009.

"The news will further fuel expectations that the Bank of England will start raising interest rates sooner rather than later, with November looking the most likely month for the first hike," said Chris Williamson, chief economist at Markit.

Separate figures showing that house prices rose by a monthly rate of 0.8 per cent in May also reinforced expectations that the central bank will have to raise borrowing costs to prevent another potentially destabilizing housing boom.

Although the markets have grown feverish about the timing of the next rate hike, Ben Brettell, senior economist at Hargreaves Lansdown cautioned that "it's important to look at the overall trend rather than one month's number in isolation, as the monthly figures can be volatile, influenced by one-off factors."

Much of the increase in the June inflation rate, he noted, was due to demand for clothing. Usually prices fall in the summer during the traditional sales season, but Brettell said the warm weather may have led retailers to delay or trim reductions as consumers took to the malls.

More insights into the Bank of England's thinking will emerge in August when it publishes its quarterly economic projections and the first estimate of second-quarter economic growth on July 25. The consensus in the markets is that the U.K. economy, Europe's third-largest, grew by a quarterly rate of 0.8 per cent during the three-month period, equivalent to an annualized rate of around 3.2 per cent.

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