The Bank of England is seen in the City of London
By Andy Bruce and David Milliken
LONDON (Reuters) - British consumer prices rose last month at the fastest pace since June 2014 and are set to rise further, propelled by higher global oil prices and the Brexit-fuelled fall in the pound, official data showed on Tuesday.
Consumer prices increased by 1.8 percent compared with a year earlier, picking up from 1.6 percent in December, and prices paid by factories jumped by more than 20 percent.
The Bank of England expects inflation to approach 2.7 percent by the end of the year while many economists say it will go above 3 percent, putting to the test the BoE's decision to keep interest rates at a fraction above zero.
Stronger inflation will strain the spending power of British households who have so far helped the economy withstand the shock of last June's vote to leave the European Union.
Sterling fell below $1.25 and government bond prices rose after January's inflation reading came in slightly below expectations for a 1.9 percent annual rise in a Reuters poll of economists, as clothing prices dragged.
"We're only seeing the thin end of the wedge in terms of inflation," said Richard Lim, chief executive of consultancy Retail Economics. He noted that hedging contracts taken out by retailers to protect against sterling's fall were unwinding.
"We expect inflation will accelerate sharply in the coming months, hitting 3 percent by the end of the year," he said.
Factories suffered the sharpest annual rise in prices since September 2008 as raw material costs jumped. The major factor was the price of oil: in dollar terms, the cost of North Sea crude at the end of January was around 60 percent higher than a year earlier, when it had touched a 12-year low.
A Reuters poll of economists published on Tuesday suggested inflation will average 2.6 percent this year and next - similar to the BoE's forecasts. [ECILT/GB]
INFLATION RISK? SLOWDOWN RISK? THE BOE'S TRADE-OFF
The pound's fall - it is down about 17 percent against the U.S. dollar and 11 percent against the euro since the Brexit vote - is starting to hit consumers, whose spending has helped the British economy to grow since the vote.
Last week BoE rate-setter Kristin Forbes said she was beginning to become uncomfortable with the central bank's commitment to a neutral policy stance, arguing instead that interest rates may need to rise soon if price pressures continue to build.
But most of her colleagues have given no sign they want to raise rates soon, given the uncertain outlook for Britain's economy as the country leaves the EU. BoE Governor Mark Carney this month warned of "twists and turns" ahead as Prime Minister Theresa May starts two years of formal Brexit talks.
Food prices showed the smallest annual decrease since July 2014 as the cost of chocolate and sweets rose by almost 5 percent on the month.
Retail price inflation - tracked by British inflation-linked government bonds and many commercial contracts - also rose to its highest since June 2014, at 2.6 percent.
Excluding oil prices and other volatile components such as food, core consumer price inflation held steady at 1.6 percent, confounding economists' expectations for a rise to 1.8 percent.
Data on factory gate prices underscored the inflationary pressures in the pipeline. Output prices rose 3.5 percent on the year, the biggest increase since January 2012, compared with forecasts of a 3.2 percent increase.
December house prices showed an 7.2 percent annual rise across the United Kingdom, compared with 6.1 percent in November. Prices in London alone rose 7.5 percent on the year.
(Editing by William Schomberg and Mark Trevelyan)