Gilts and short sterling futures slid on Tuesday after data showed UK consumer price inflation rose faster than forecast in December, fuelling concerns the Bank of England may be forced to raise interest rates sooner than expected.

A surge in oil prices drove the CPI measure of inflation to an 8-month high of 3.7 percent, well above economists' forecasts and keeping the rate uncomfortably far above the BoE's 2 percent target.

CPI had been expected to hold steady at 3.3 percent, according to the median forecast of a Reuters poll of 26 economists.
A lot of people were waiting for this inflation number, said Jamie Searle, gilts strategist at Citi It's a big upside surprise and it's coming even before the (Jan. 1) VAT hike takes effect. It will encourage people to look at the chance of a May hike more closely.

At 1020 GMT, the March gilt future FLGH1 was 56 ticks lower at 117.00, broadly in line with the equivalent German Bund future.
Short sterling interest rate futures extended losses to stand as much as nine ticks down in contracts from December 2011 onwards as investors priced in more aggressive BoE action on rates.

Last October, markets were not pricing in any UK rate hike in 2011 at all. Now they are pricing in a good chance of a hike as soon as May, and a second hike later in the year.

In the cash market, short-dated gilts were hit hardest. The yield on 2-year gilts rose 7 basis points to a one-year high above 1.39 percent, compared with a rise of just 2 basis points in 2-year Bund yields.

The yield on 10-year gilts GB10YT=RR rose 5 basis points to 3.67 percent, keeping the spread over Bunds EU10YT=RR steady at around 57 basis points.

Tuesday's data marked the start of a difficult few months for the central bank, facing mounting pressure over its attempts to cut the stubbornly high inflation rate.

Before the release of the inflation data, BoE policymaker Paul Fisher said in a newspaper interview that the central bank must not become too concerned about high short-term inflation and should set monetary policy for the longer term.

Yes, it's very uncomfortable...but I wouldn't want to go back and change policy, Fisher said in an interview with the Yorkshire Post, a regional newspaper.

Two surveys overnight provided a further talking point. The Nationwide Consumer Confidence index climbed 8 points to 53 last month from 45 in November, ending three months of falls and matching October's figure.

The Royal Institution of Chartered Surveyors' seasonally adjusted house price balance nudged up to -39 from -44 in November, improving more than the consensus forecast of -42.

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