By Andy Bruce and William Schomberg
LONDON (Reuters) - Britain's jobless rate unexpectedly rose for the first time in almost two years and pay growth remained modest, leaving the Bank of England waiting for the stronger labour market that would justify a new interest rate hike.
British government bond prices rose and sterling briefly fell against the U.S. dollar after Wednesday's official figures, which showed the sharpest increase in the number of people out of work in almost five years.
Separate data showed finance minister Philip Hammond was on track to meet his targets for further cutting Britain's budget deficit this financial year.
British households lost spending power last year due a jump in inflation, caused by the post-Brexit vote fall in the pound.
But the BoE expects pay to pick up soon, a big reason why it says interest rates are likely to rise faster and to a greater extent than it thought until recently.
"With wage growth stuck in neutral, policymakers will need to think very carefully about a rate hike in May," Maike Currie, an investment director at Fidelity International, said.
The Office for National Statistics said the unemployment rate rose to 4.4 percent from 4.3 percent in the three months to December, the first increase since the three months to February 2016, as the number of jobless rose for a third monthly report in a row.
The number of people in work grew less than expected, rising by 88,000, about half the consensus forecast in a Reuters poll of economists.
The ONS attributed the rise in unemployment to fewer economically inactive people - those neither working nor looking for a job - entering unemployment, rather than people in work losing their jobs.
Workers' total earnings, including bonuses, rose by an annual 2.5 percent in the three months to December, as expected and unchanged from the three months to November.
BoE officials may take encouragement from pay jumping 2.8 percent on the year in December alone. But that was still weaker than the 3.0 percent reading of British consumer price inflation for December.
Excluding bonuses, earnings rose by 2.5 percent year-on-year against expectations for a 2.4 percent rise.
The ONS said the number of EU nationals working in Britain rose by an annual 4.5 percent over the fourth quarter, the smallest increase since the third quarter of 2013. The number of Eastern European workers fell.
Overall migration data has shown a drop in net migration from the EU into the UK since the Brexit vote.
The ONS also published its first estimate for productivity in the fourth quarter.
Output per hour - the main measure of productivity - rose 0.8 percent in the three months to December from the previous three months, slightly slower than the third quarter's 0.9 percent rise. That marked the strongest two quarters for productivity since the 2008/09 recession, the ONS said.
DEFICIT PLAN ON TARGET
Separate figures showed Britain's government recorded a January budget surplus of 10 billion pounds, slightly bigger than forecast, helped by a surge of income tax receipts that typically comes at the start of the calendar year.
With only two months left in the 2017/18 financial year, cumulative borrowing now stands at 37.7 billion pounds, down 16 percent on the same point a year ago.
In November, the official budget watchdog had forecast borrowing of 49.9 billion pounds for the full year.
The finance ministry said Wednesday's figures were strong.
(Editing by Toby Chopra)
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