Prospect of higher interest rates

On a dramatic day for the UK economy, the rate of 3.1% for March triggered an unprecedented letter from the Bank explaining to Chancellor Gordon Brown why inflation was more than 1% above its target of 2%.

Bank governor Mervyn King said in the letter that he was "determined" to set interest rates at the level required to bring inflation back on track, although he also pledged to look through any short-term volatility.

Economists who had previously been looking for one more rate rise to 5.5% began speculating about increases to 5.75% or even 6% later this year.

Philip Shaw, chief economist at Investec Securities, said: "Today's figures mean that a May hike is now even more of a cast-iron certainty than previously. Our forecast that rates will peak at 5.5% is under review."

The prospect of higher borrowing costs - following three rate hikes since last August - caused sterling to trade above two US dollars, following several weeks of resistance to that level. It is expected to remain above two US dollars as rates in the United States are forecast to fall, in contrast to the UK.

Mr King's letter - the first since the Bank of England was given control of interest rates almost 10 years ago - said the Bank's Monetary Policy Committee (MPC) expected the Consumer Prices Index (CPI) to fall back within target in "a matter of months".

But he added that the committee's next meeting would consider "very carefully" whether other upward pressure on inflation was materialising.

In response, Mr Brown said that the MPC, which sets interest rates, had helped deliver a "decade of low and stable inflation" and said the Government would continue to support the work of the committee. The inflation rise emerged as the Chancellor prepared to face a Commons vote of no confidence over his handling of occupational pensions.

The Office for National Statistics (ONS) said the higher CPI rate of inflation was driven largely by the rising cost of food and non-alcoholic drinks, with milk prices soaring by more than 2% in March compared with a fall of 8% last year. Higher petrol prices also put upward pressure on the cost of living, rising by 2.5p per litre in March as crude oil prices increased to around 64 US dollars (£32) a barrel.