PAY deals are set to increase because of an expected rise in headline inflation, a new report has predicted.

The cost of living is forecast to climb to 3.5 per cent over the next few months - setting a higher starting point for pay negotiations, said a report by pay analysts Incomes Data Services (IDS).

IDS head of pay services, Alastair Hatchett, said: "Higher inflation this autumn will have a strong impact on the pay bargaining in January 2005 and April 2005, the two key months in the pay calendar.

"Inflation at 3.5 per cent will provide a higher baseline for next year's pay negotiations. The labour market remains strong and economic growth will underpin upward pressures on pay."

Pay settlements have been "remarkably" stable at 3.0 per cent for the past year, the report found.

"Recruitment salaries have been rising in many sectors and market-related pay adjustments can be expected on top of increases made as part of annual pay reviews," said the report.

Yesterday record oil prices were blamed for the sharpest annual rise in the cost of goods leaving UK factories since April 1996.

The government figures, which show a 3.1 per cent increase in prices in the year to September, were announced on the day that the cost of Brent crude in London broke through the $50 a barrel mark for the first time.

City experts said the willingness of firms to pass on the higher energy costs raised fears of inflationary pressures building in the UK economy.

HSBC's John Butler said: "If costs continue to rise, the question is whether retailers take a permanent squeeze on margins or seek to raise their own prices?"

Gerrard chief economist Simon Rubinsohn said the figures would concern the Bank's Monetary Policy Committee (MPC), although he believed members would resist the temptation to raise rates next month in order to cool inflation.

"While an early breach of the MPC's 2.0 per cent inflation target is still improbable, the data highlights the key risk over the next year if the oil price continues to buck expectations."

First published: Oct 12