Consumer prices rose 8.9 percent during 1981, the smallest increase in four years, the Labor Department reported yesterday.

The recession, ample oil supplies and bumper farm crops combined to trim the rate from 12.4 percent the year before. The Consumer Price Index rose 0.4 percent in December and at an annual rate of 5.3 percent in the final quarter of the year, while the recession was at its worst.

Grocery store prices rose 3 percent nationally, a sharp drop from the 10.6 percent rate the year before. The Washington area did even better, with food prices dipping 0.2 percent for the year.

The CPI increase means that annuity checks for about 100,000 retired federal and military personnel in the Washington area will go up 8.7 percent in April. It will be their first cost-of-living increase in a year. Details on Page G7.

Meanwhile, the Federal Reserve said the nation's money supply rose $700 million in the week ended Jan. 13, adding to the recent unexpected bulge that may force the Fed to tighten credit again. Financial analysts had expected a drop of $3 billion to $4 billion in the wake of a $10.2 billion jump the week before.

The increase in the measure of money known as M-1, which includes currency in circulation and checking account balances at financial institutions, could spark new criticism of the Federal Reserve's procedures for managing the money supply, particularly from Treasury Secretary Donald T. Regan.

President Reagan and Regan both complained this week about the recent growth of money, with the president saying it was sending "the wrong signals" to financial markets.

Economists are worried that any tightening by the Fed could force interest rates up and jeopardize the recovery from the recession which most forecasters are predicting for later this year.

In an interview yesterday, Murray L. Weidenbaum, chairman of the president's Council of Economic Advisers, said "the key thing is economic growth" in assuring a downward trend in federal budget deficits. Large deficits increase the pressure on the Fed, since financing them uses funds that otherwise would be available to private borrowers.

Weidenbaum predicted a sharp economic upturn this year after the 5.4 percent drop in real activity in the last quarter of 1981. His predictions are for a 2.0 percent drop in the first quarter of this year, a zero to fractional increase in the second quarter, and a surge averaging more than 5 percent in the final two quarters.

When the Consumer Price Index for December was announced, White House spokesman Larry Speakes said, "We welcome the year-end result on this key indicator of progress against inflation. A 3-percentage-point drop in the CPI is substantial progress."

The administration and most private economists expect additional progress against inflation this year, with the CPI going up about 8 percent. Administration projections call for a further drop in the rate to about 6 percent in 1983.

Allen Sinai of Data Resources Inc., an economic consulting firm, said the primary reason for the inflation improvement last year was "the prolonged slack in the economy. It wasn't just luck on oil and food prices , it was very much the result of the stagnant economy that brought the prices down." Nevertheless, Sinai summed up the view of many economists when he added, "We're ahead on the battle on inflation."

The Labor Department report said that the increases in every major sector of the CPI were smaller in 1981 than the year before except for medical care. Last year medical care costs rose 12.5 percent, compared to 10 percent in 1980.

By far the most significant drop was in the food area. The food and beverages sector, which includes alcoholic beverages and food bought in restaurants as well as grocery stores, rose 4.3 percent last year, down from 10.1 percent in 1980. It was the second year in a row that food prices rose less swiftly than the overall index.

Home-ownership costs, which include mortgage interest, rose at a 10.1 percent rate last year after climbing 16.5 percent in 1980. Gasoline prices went up 9.4 percent last year, almost precisely half the 18.9 percent rate a year earlier.

The deceleration in inflation in the final quarter of the year was the result of smaller increases in all major spending categories, with food and housing leading the way.

The Consumer Price Index rose to 28l.5 in December, which means that a marketbasket of goods and services that cost $10 to purchase in 1967 now costs $28.15.