The Bank of England governor has had to write the first ever letter to the UK chancellor explaining why annual inflation is so far above target, following an unexpected leap from 2.8% to 3.1% which yesterday fuelled fears of higher interest rates.

A further quarter-point rise in UK base rates to 5.5% on May 10 is now viewed by the City as virtually a done deal, and economists now see a significant chance of the cost of borrowing going higher still by the year-end.

Forty-nine of 51 economists polled yesterday by the news agency Reuters forecast that the Bank's Monetary Policy Committee would implement the fourth quarter-point increase in base rates this cycle when it meets next month. The poll put the probability of rates rising to 5.75% or higher by the year-end at a punchy 35%, and financial markets are pricing in fully two quarter-point increases between now and November.

The leap in annual UK Consumer Prices Index inflation from 2.8% in February to 3.1% last month - the highest since comparable records began in January 1997 - sent the pound through $2 for the first time for nearly 15 years when it was announced yesterday morning by National Statistics.

While the City had seen a danger of inflation rising in January to the 3.1% level which triggers an explanatory letter, it was wrongfooted entirely by the figures yesterday showing that it had moved more than one percentage point above the Bank's target last month.

Food and non-alcoholic drinks exerted the biggest upward effect on annual CPI inflation, with shop-bought milk prices rising by more than 2% last month in contrast to an 8% fall in March last year when supermarkets led widespread reductions.

Prices in the furniture, household equipment, and routine maintenance category showed a record monthly rise of nearly 10% in March. Petrol prices also exerted an upward impact on overall inflation, rising by nearly 2.5p per litre in March, compared with little change in the same month last year.

Bank of England governor Mervyn King says in his letter to Chancellor Gordon Brown, published yesterday, that "CPI inflation is likely to fall back within a matter of months" as recently announced falls in household gas and electricity prices take effect and substantial increases in these fuel bills a year earlier drop out of the annual comparison. He cites the impact of "an unexpectedly sharp increase in domestic energy prices during the second half of last year" and a rise in food prices "caused by a weather-induced global reduction in supply" as factors in the jump in annual CPI inflation to 3.1% from 1.8% in March last year.

However, sounding hawkish, King emphasises that "taken together, those factors account for only around one-half of the pick-up in CPI inflation over the past year".

Highlighting consumer strength, he adds: "It appears that some of the risks identified by the Monetary Policy Committee over the past year have started to materialise. Spending in the UK economy, associated with continuing rapid growth of money and credit, has recovered from the slowdown in 2005, leading to five consecutive quarters of robust growth. Capacity pressures have increased.

"Against that background, businesses have become more confident that they could raise prices to rebuild profit margins, which had previously been squeezed by the doubling in world oil prices since 2004."

King appeared to take the writing exercise in his stride, even though it was the first letter which had to be sent since the Bank was granted independence in setting interest rates when Labour came to power in 1997. He claims in the letter he is "surprised that it has taken 10 years and 120 meetings of the Monetary Policy Committee before a deviation of inflation from target sufficient to trigger a letter has arisen".

He highlights in his letter a near-25% leap in the sterling oil price since February. The Bank said yesterday this referred to an increase from £27.90-a-barrel for Brent crude around the time of the MPC's February inflation report to a level of about £34.50 over the past week.

King also emphasised the importance of keeping the public's inflation expectations "anchored" on the 2% target, but claimed the March inflation news "at first sight...seems unlikely to alter the broad picture painted in the February (inflation) report".

A supportive Brown, while highlighting his own part in trying to keep a lid on inflation by ensuring headline pay settlements for public sector workforces covered by pay review bodies would be less than 2% in 2007/08, says in his letter of response to King: "I agree that the Monetary Policy Committee's approach is appropriate."

Annual inflation on the old all-items retail prices index measure, still used widely in private sector pay bargaining, jumped from 4.6% in February to 4.8% in March. This was the highest since July 1991.

Lucy O'Carroll, director of research at HBOS's treasury services division, was confident yesterday's inflation numbers supported her long-standing forecast of a May rate rise.

She said: "Though the governor may, as he states in the letter, welcome the opportunity to explain himself in this way, he is unlikely to want to have to do it too often."

However, in spite of a growing belief in the City that 5.5% might not be the peak for base rates after all, she added: "The fact that the governor does not think that the story has changed much from February suggests that the peak is still likely to be 5.5%."