British inflation figures, worse-than-expected at an annual rate of 4.2 per cent last month, prompted new City speculation of still higher interest rate rises following the quarter-per cent increase to 7.50 per cent sanctioned by the Bank of England earlier this month.

Another quarter per cent rise to 7.75 percent next month is being predicted by City economists and there will be no surprise if 8.0 per cent in the autumn marks the peak of the interest rate cycle.

Suggestions of higher UK interest rates led to heavy buying of sterling on the currency markets. The British currency rose a further 1.15 pfennigs to 2.9719 Deutschmarks after Monday's two-pfennig surge mainly due to worries about Germany's exposure to Russian economic difficulties. Sterling has now rallied nearly 10 pfennigs over the past month as markets have adjusted to the prospect of rising, rather than falling, interest rates. The "headline" Retail Price Index measure of UK inflation rose last month from 4.0 to 4.2 per cent, the highest monthly rate since May 1992 and significantly worse than the expected 3.9 per cent rate predicted by City economists.

Poor weather led to an 11.2 per cent increase in seasonal food prices, the largest for more than 30 years.

But big price rises increases in household goods and other items indicated that the rise in inflation was not due to "one-off" factors. Underling inflation excluding mortgage interest payments rose 0.6 per cent to 3.2 per cent, the highest level since November 1996 and well above the government's 2.5 per cent target. Excluding indirect taxes and mortgages, the year-on-year inflation rate also edged up 0.3 per cent to 2.5 per cent.

Last month's interest rate increase was sanctioned by the Bank of England's monetary policy committee on concerns about the inflationary consequences of high pay rises in the private sector.

Now, the worse-than-expected inflation figures confirm the ability of retailers, particularly in the household goods sector, to restore profit markets through higher prices.

Even so, the British economy is being unbalanced by the impact of strong sterling on manufacturing industry.

Export orders are in retreat and competition from overseas suppliers is increasing in the domestic market.

By contrast, the services sector protected from changes in sterling is continuing to boom on the back of the buoyant housing market, particularly in London and the south-east.

Over time, higher interest rates will prick the new housing bubble and reduce inflationary pressures.

In the meantime, though, manufacturing industry in the Midlands, North of England and Scotland will be brought to the verge of recession through sterling's ascendancy on the foreign exchanges.