Feb. 4 (Bloomberg) -- An index measuring Australian consumer prices rose at the fastest annual pace in 20 months in January, reinforcing speculation the central bank will increase interest rates tomorrow.

Prices climbed 3.9 percent from a year earlier, breaching the 3 percent limit of the central bank's target, according to a monthly gauge released by TD Securities Ltd. and the Melbourne Institute in Sydney today. Prices advanced 0.3 percent from December, when they gained 0.6 percent.

Surging fuel costs and soaring home rents drove a pickup in inflation that may prompt Reserve Bank Governor Glenn Stevens to add to last year's two interest-rate increases. Price pressures are building as China's demand for Australian commodities prompts miners to hire workers, worsening a skills shortage that is stoking wages and consumer spending.

``Inflation remains problematic and the Reserve Bank of Australia will need to tighten monetary policy further,'' said Joshua Williamson, a senior strategist at TD Securities in Sydney. ``Unless inflation pressures ease in the short-term, further rate hikes cannot be ruled out.''

The central bank will increase its benchmark rate by a quarter point to an 11-year high of 7 percent tomorrow, according to 25 of 27 economists surveyed by Bloomberg News. Two forecast no adjustment as the bank monitors fallout from the U.S. housing recession on global economic growth.

Dollar, Bonds

The Australian dollar traded at 90.28 U.S. cents at 10:32 a.m. in Sydney from 90.27 cents immediately before the report was released. The yield on the benchmark five-year bond rose to 6.60 percent from 6.51 percent at close of trading on Feb. 1.

A 25 percent surge in the price of gasoline in the 12 months through January contributed most to the overall increase in the inflation gauge, today's report showed. The price of rental accommodation in Australia jumped 9.1 percent in the year, the biggest gain since the index began in August 2003.

The Reserve Bank is charged with keeping annual price gains between 2 percent and 3 percent on average.

Australia's weighted-median measure of core inflation, which excludes the largest price fluctuations, climbed 3.8 percent in fourth quarter from a year earlier, official government figures showed. The central bank uses the measure to monitor underlying inflation pressures in the economy.

Stevens and his board increased the overnight cash rate target by a quarter point in both August and November last year.

The Melbourne Institute is a research unit of Melbourne University and TD Securities is a division of Toronto-Dominion Bank, one of Canada's largest banks. The inflation index measures the prices of 1,000 goods and services.

To contact the reporter on this story: Tracy Withers in Wellington at twithers@bloomberg.net.

Last Updated: February 3, 2008 18:36 EST