By Andy Bruce and Paul Sandle
LONDON (Reuters) - British inflation sank unexpectedly to a more than three-year low in December as hotels slashed prices, ramping up expectations that the Bank of England will cut interest rates as soon as this month.
Consumer prices rose by 1.3% in annual terms compared with 1.5% in November, the smallest increase since November 2016, the Office for National Statistics (ONS) said on Wednesday.
The pound slid below $1.30 and British government bond prices shot higher on the reading, which was below all forecasts in a Reuters poll of economists that had pointed to another 1.5% increase.
Since the turn of the year, BoE officials have voiced concerns about the strength of Britain's economy, raising expectations in financial markets that they could vote to cut interest rates as soon as this month.
Earlier on Wednesday, BoE rate-setter Michael Saunders said interest rates should be cut straight away, citing a weak labor market and a sluggish economy, to avoid Britain getting stuck in a low-inflation trap as in the euro zone.
Although Wednesday's data showed inflation for the fourth quarter as a whole matched the BoE's 1.4% forecast it made in November, the surprise drop in price pressures last month bolstered expectations of stimulus.
Money markets now price in a roughly 56% chance of a rate cut in January, compared with 49% before Wednesday's data.
"These figures back up outgoing Bank of England Governor Mark Carney's suggestion that there is clear headroom to cut interest rates to stimulate the economy if required," said Robert Alster, head of investment services at Close Brothers Asset Management.
The ONS said a third of hotels surveyed in December reported falling prices, compared with only one in 10 reporting an increase.
Women's clothing prices also fell, the ONS said.
A measure of core inflation, which excludes energy, fuel, alcohol and tobacco, dropped to its lowest since November 2016 at 1.4%, down from 1.7% in November.
Inflation pressure in the pipeline -- measured through factory prices -- remained muted. Prices of manufactured products rose 0.9% on the year, as expected in the Reuters poll.
Separate data from the ONS showed house prices rose by an annual 2.2% in November, the biggest rise in a year, adding to tentative signs of stabilization in the housing market.
(Graphic by Sujata Rao; Editing by Catherine Evans)