June 12 (Bloomberg) -- The U.K.'s inflation rate fell to the lowest in seven months in May after utilities cut gas and electricity bills.

Consumer prices rose 2.5 percent from a year earlier after gaining 2.8 percent in April, the Office for National Statistics said in London today. So-called core inflation, which excludes food, alcohol, energy and tobacco, accelerated to 1.9 percent from 1.8 percent, matching the highest level since 1997.

``The increase in core inflation is ongoing and that means inflation may go back up,'' Alan Clarke, an economist at BNP Paribas in London, said in an interview. ``We're still in a hiking environment, and not only in the U.K.''

Britain's inflation rate has exceeded the bank's 2 percent target for 13 months, extending the threat that higher living costs become entrenched in the economy. Bank of England Governor Mervyn King said yesterday that policy makers ``may need to take further action'' to quell consumer prices after they kept the benchmark interest rate at a six-year high last week.

``Another rate hike seems to be locked in,'' said Amit Kara, an economist at UBS AG in London who formerly worked for policy makers at the central bank. ``If inflation continues to slow like this, the next rate increase may be the final one.''

Economists' Expectations

The median forecast of 33 economists in a Bloomberg News survey was for an inflation rate of 2.6 percent. On the month, prices rose 0.3 percent, the same as in April. Economists had expected the core figure to remain at 1.8 percent.

Investors are betting the bank will raise interest rates from the current level of 5.5 percent before the fourth quarter. The implied rate on the September interest-rate futures contract rose 0.03 percentage point today to 6.09 percent as of 12:23 p.m. in London. The March contract is up 0.06 percentage point to 6.27 percent.

The contracts settle to the three-month London interbank offered rate for the pound, which averaged about 15 basis points more than the central bank benchmark for the past decade.

The consumer price index fell because of cuts in gas and electricity costs compared with a year earlier, the statistics office said. Lower prices for food, clothing and footwear also pushed down inflation, offsetting higher costs of transport.

Cheaper Utilities

U.K. utility companies including Windsor-based Centrica Plc, the country's biggest energy supplier, have cut their power and gas charges this year after wholesale prices fell.

The bank's May 16 forecasts show inflation may reach the target in two years if interest rates rise by a quarter point.

King said in a speech yesterday that policy makers will monitor measures of capacity utilization, firms' pricing intentions and Britons' outlook for prices to see if policy makers need to do more to tame prices.

``If these indicators remain elevated, the monetary policy committee may need to take further action,'' King said.

The bank governor said May 16 that there was an ``upside'' inflation risk from companies charging their customers more. U.K. factory-gate prices rose for a sixth month in May as manufacturers raised the costs of gasoline and food products, a statistics office report showed yesterday.

Wage Gains

Policy makers noted last month that salary agreements could pose a risk to inflation. King said yesterday that while measures of average earnings seem subdued, the data were ``sending conflicting signals.''

The retail price index, which includes mortgage payments and is used in wage negotiations as a measure of the cost of living, fell to 4.3 percent in May, the lowest since January. The rate reached 4.8 percent in March, the highest since 1991.

Excluding mortgage interest payments, retail price inflation was 3.3 percent, the lowest level in seven months.

Economists are split on the timing and extent of further interest-rate increases by the central bank to bring inflation under control. Lombard Street Research economist Michael Taylor predicts a quarter-point move to 5.75 percent as soon as next month with another to follow later in the year.

National Australia Bank economist Tom Vosa, who formerly worked at the central bank, disagrees. He predicts a quarter-point increase in August will be the bank's last move for now.

``We haven't really seen the full effects of the previous rate increases, but once these start coming through activity will ease,'' he said. ``They can take their time raising rates again.''

A separate report today showed the U.K. goods trade deficit narrowed to 6.3 billion pounds ($12.4 billion) in April, the least since October 2005 and down from a revised 7.2 billion pounds in March. Economists forecast 7 billion pounds, according to the median of 24 estimates in a Bloomberg News survey.

A drop in oil imports and an increase in exports of the commodity accounted for about half of the narrowing of the trade deficit, the statistics office said.

To contact the reporters on this story: Jennifer Ryan in London at Jryan13@bloomberg.net.

Last Updated: June 12, 2007 07:44 EDT