The number of Britons claiming unemployment benefit fell by 11,000 to 813,200 last month, its lowest level since June 1975, National Statistics said. The number in work was, at 28.5 million, 90,000 higher in the last three months of 2004 than the quarter before and the highest figure since records began in 1971.

The data fuelled City fears of a labour squeeze likely to feed through into higher inflation, despite a 32,000 rise in the number of people unemployed as measured by International Labour Organisation standards. The increase took to 1.41 million the total number of Britons without work in the October-to-December period.

"Although ILO unemployment rose in the three month period Oct-Dec this does not really represent the tone of the report," Deutsche Bank said.

"Of more importance is the strength in employment. If hiring strength is genuine, then it is a positive factor for consumer spending and the housing market."

The report also revealed a 0.1 point rise to 4.5 per cent in wage growth, a figure considered as raising inflationary alarm bells at the Bank of England.

Howard Archer, the Global Insight economist, said: "With the labour market tight and inflation recently higher, there is the clear risk that pay settlements will pick up further over the coming months.

"Consequently, we continue to believe the odds are moving towards the Bank of England raising interest rates around May/June."

At HSBC, economist John Butler said: "The battle for whether the next move in interest rates is up or down will be decided in the labour market.

"We expect wage growth to continue to pick up and as a result we still expect a near term rate hike."

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