Energy regulator Ofgem has launched an investigation into the markets in electricity and gas for households and small businesses.

Ofgem's inquiry follows a series of inflation-busting price hikes announced recently by big energy firms.

The regulator has no strong evidence of failure in the gas and electricity market. But it said recent events had damaged public confidence.

Ofgem Chief Executive Alistair Buchanan said: "The decision to conduct the probe is in

response to public concern about whether the market is working effectively. We are concerned about the increased volatility of wholesale prices and we want to investigate how European and other global energy market developments are affecting energy bills in Britain.

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"We, of course, keep the market under constant surveillance but to date we have seen no clear evidence that the market is failing.

"Nevertheless, recent events in the market have increased public concern and have damaged customers' confidence that competition is working well and giving them a good deal. Customer confidence is vital for a well-functioning market. So we shall replace our magnifying glass with a microscope and take a more detailed look at the retail market and the influence of global wholesale market developments."

Its investigation will include the relationship between retail and wholesale energy prices. UK gas and electricity firms have blamed their recent price hikes on soaring wholesale costs.

The inquiry will be carried out under Ofgem's Enterprise Act powers, with its initial findings due to be published before the end of September.

Ofgem's inquiry comes as British Gas announced a 500% increase in annual profits for its residential arm.

The Centrica-owned supplier revealed that underlying operating profits last year leapt to £571m from £95m in 2006, contributing to a 40% surge in group-wide profits.

(CD/JM)