Jan. 14 (Bloomberg) -- U.K. factories increased prices at the fastest annual pace since 1991 in December, reducing the Bank of England's scope to cut interest rates further as economic growth slows.

Manufacturing output prices rose 5 percent from a year earlier after a 4.7 percent gain in November, the Office for National Statistics said in London today. Economists predicted 4.7 percent, the median forecast of 26 economists surveyed by Bloomberg News showed. Prices rose 0.5 percent on the month.

The Bank of England decided not to lower the benchmark interest rate last week after a cut in December as policy makers balanced the threat of inflation from higher energy prices against a forecast for a ``sharp'' economic slowdown. The pound fell to a record low against the euro today as investors bet the bank will reduce borrowing costs again as soon as next month.

``This may diminish speculation of more aggressive rate cuts because it shows companies can still pass on higher costs,'' said Kenneth Broux, an economist at Lloyds TSB Group Plc in London, in an interview. ``The bank will still have to focus on slower growth.''

Faster producer-price gains may take time to feed through to consumer prices. Economists forecast the December inflation rate to have dropped to 2 percent, the Bank of England's goal, a survey showed. The statistics office reports that data tomorrow. The rate has been higher than the target for two months.

Bank's Challenge

``The challenge for the Monetary Policy Committee at present is that inflation may rise in the near-term, posing a risk to inflation expectations, and could fall below target further ahead in the event of a sharp slowing in output growth,'' central bank Governor Mervyn King told U.K. lawmakers in testimony on Nov. 29.

The central bank predicts that the U.K. economy will probably grow around 2 percent this year, close to the lowest rate since 1992, after 3 percent expansion this year. Economists expect the Bank of England benchmark rate to fall to 4.75 percent from the current 5.5 percent by the end of the year, a Bloomberg News survey from Jan. 4 showed.

Producer prices rose for a fourth month, led by gains in gasoline, food and chemical products, the statistics office said. On the year, aviation fuel climbed 11.6 percent, the most since July 2005, while gasoline-product costs rose 20.5 percent, the biggest increase in more than seven years.

Pricing Power

``There is pipeline price pressure, but the scope to pass it on is limited, said Peter Dixon, an economist at Commerzbank AG in London, before the report. ``Output prices aren't going up as much as input prices, so profit margins are going to be squeezed throughout 2008.''

Raw-material costs rose 0.5 percent on the month and 11.3 percent on the year, the statistics office said. Crude oil reached a record $100.09 per barrel on Jan. 3, and traded at $93.26 today.

Rolls-Royce Group Plc, Europe's biggest maker of aircraft engines, plans to eliminate as many as 2,300 jobs, or 6 percent of its workforce, to help counter the effects of higher raw- material expenses, the company said Jan. 11.

The pound fell to 75.900 pence against the euro at 12:25 p.m. in London, the weakest since the European currency was introduced in 1999. It also fell to a nine-month low against the dollar, increasing the cost of imports denominated in the U.S. currency. The pound was little changed against the dollar at $1.9621 after today's report.

Policy makers are ``correct to be concerned about imported inflation from manufactured goods and food and energy feeding through to manufacturing, while the weakness of sterling can have an effect,'' said Philip Shaw, chief economist at Investec Securities in London, in a Bloomberg Television interview.

To contact the reporter on this story: Brian Swint in London at bswint@bloomberg.net.

Last Updated: January 14, 2008 07:36 EST