June 17 (Bloomberg) -- U.K. inflation reached the highest since at least 1997 in May, and Bank of England Governor Mervyn King predicted it will exceed 4 percent later this year, adding to speculation that the economy will fall into a recession.

The Monetary Policy Committee ``is concerned about the present and prospective period of above-target inflation,'' King wrote in a letter to the government, after the Office for National Statistics said consumer prices climbed 3.3 percent from a year earlier last month. ``The path of bank rate that will be necessary to meet the 2 percent target is uncertain.''

The pound fell after the inflation data, which fueled speculation that rising prices will curb growth and push the economy closer to a recession. The Labour government decreed in 1997 when it came to power that the central bank governor must write to explain if inflation strays more than a point from the target, which has only happened once before.

Policy makers ``are going to sit on their hands for the time being since there's not really much they can do for the moment,'' said George Buckley, chief U.K. economist at Deutsche Bank AG in London. ``They need to see what the economy does first.''

The pound dropped against the dollar and the euro. Britain's currency fell as much as 0.8 percent to $1.9506 as of 12 p.m. in London. Against the euro, it dropped 0.8 percent and traded at 79.46 pence. The yield on two-year government bonds also fell 18 basis points to 5.339 percent.

Inflation Rate

The inflation rate reached the highest since the index began 11 years ago, the statistics office said today in London. Economists predicted 3.2 percent, according to the median of 39 forecasts in a Bloomberg News survey.

Inflation ``is likely to remain markedly above the target until well into 2009,'' King said in the letter, released by the bank today in London. ``The committee will maintain price stability by ensuring that the rise in inflation is temporary.''

Chancellor of the Exchequer Alistair Darling replied that ``the government will continue to support the Monetary Policy Committee in the forward-looking decisions it takes.''

Accelerating inflation may add to dissatisfaction among voters at a time when support for Prime Minister Gordon Brown's Labour Party is at the lower since polling began in 1943, a YouGov Plc survey released on May 30 showed. Seventy-three percent of respondents predicted their financial situation will worsen in the next year, the poll showed.

Interest Rates

At 5 percent, Britain's interest rate is the highest in the Group of Seven industrialized nations. U.K. inflation is also lower than the rest, and compares with 4.2 percent in the U.S. and 3.7 percent the 15 countries sharing the euro.

German investor confidence dropped to the lowest in 15 years in June as surging inflation dimmed the outlook for growth, the ZEW Center for European Economic Research said today.

U.K. inflation was led by food, non-alcoholic beverages and energy in May, the statistics office said. While the index began in 1997, a constructed gauge using data which isn't directly comparable shows the rate is now the highest since July 1992.

``I don't think it will trigger an interest rate rise,'' Trevor Williams, an economist at Lloyds TSB Bank Plc, said in an interview with Bloomberg Television. ``The consequences of trying to do something about this now are recession. What is needed is a period of sub-trend growth.''

So-called core inflation, which strips out food, energy, tobacco and alcoholic drinks, was 1.5 percent, the highest since October last year.

Letter Writing

The only previous letter was in April 2007, after inflation reached 3.1 percent the previous month. At the following decision in May, they raised the main interest rate in the first unanimous change in the benchmark for almost three years.

King said on May 14 that inflation may exceed 3 percent for several quarters, which would require him to write to the government again in three months, according to the 1997 law that gave the Bank of England control over interest rates. He said today that inflation may exceed 4 percent, compared with the bank's previous forecast of a peak at 3.75 percent.

Crude oil prices surged to a record above $139 a barrel yesterday and corn climbed to a record near $8 a bushel. Higher commodity prices pose a ``serious challenge'' to the world economy, officials from the Group of Eight nations said June 15.

U.K. food prices increased 8.7 percent from a year earlier, the statistics office said. The cost of meat rose 8.8 percent, twice the annual rate as in April, and vegetable prices increased 7.2 percent in the year.

Food Prices

Higher food prices ``are here to stay,'' Peter Brabeck- Letmathe, chairman of Nestle SA, the world's largest food company, said yesterday. Virgin Atlantic Airways Ltd., the U.K. carrier controlled by billionaire Richard Branson, said June 11 that the world airline industry needs a radical increase in prices to survive surging fuel costs and slowing economic growth.

King said last month that the U.K. may see a ``quarter or two of negative growth.'' The economy will grow 1.3 percent next year, the least since 1992, the Confederation of British Industry, the U.K.'s biggest business lobby, predicted yesterday.

``If bank rate were set to bring inflation back to the target within the next 12 months, the result would be unnecessary volatility in output and employment,'' King wrote in the letter released today.

The slowdown may still curb inflation. Tesco Plc, the U.K.'s biggest retailer, cut prices on more than 12,500 products in Britain in the first quarter to retain customers. Consumer confidence dropped to the lowest level since Margaret Thatcher was ousted from office in 1990, GfK NOP Ltd. said May 30.

Inflation Expectations

Britons anticipate inflation will reach 4.3 percent in the next year, the highest reading since at least 1999, the central bank said last week, citing a May survey by GfK NOP.

``There's a sense out there that inflation is running away,'' said James Shugg, an economist at Westpac Banking Corp. in London. ``The Bank of England should worry about inflation expectations.''

Policy makers say they're concerned workers will demand pay increases to compensate for rising living costs. The retail price index, which wage negotiators still use as a benchmark, rose 4.3 percent from a year earlier. Excluding mortgage interest payments, prices gained 4.4 percent, the most since 1992.

King and the other eight central bank policy makers voted to keep the benchmark interest rate unchanged on June 5. The minutes of that meeting, revealing how each member voted, will be published tomorrow. The next interest-rate decision is July 10.

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

Last Updated: June 17, 2008 07:09 EDT