Volumes in the final quarter rose by 4.6% or 20,516 units, the strongest rate of growth since the first quarter of 2004, according to figures from the Society of Motor Manufacturers and Traders.
Registrations for December rose for the fourth successive month and for the ninth time in 2007.
Fuel-efficient diesel models took a record share, 40.2% or 967,436 units, 'supermini' and small family cars also posted growth, up 17,729 and 25,084 units respectively.
The average new car CO2 figure dropped by 1.4% year on year to 164.9 g/km, a fall of 13.1% since 1997.
Paul Everitt, new SMMT chief executive, said: "Last year, demand for new cars was stronger than many had predicted.
"There is little sign that the US credit crisis or rising fuel prices have affected demand and we foresee only limited changes through 2008. The UK economy currently remains resilient and the new car market is ultra-competitive.
"Car makers will continue to fight hard for every sale and consumers will benefit from unprecedented choice and excellent deals."
The Ford Focus was the best seller in 2007 and has been every year since 1999. Almost 1.2 million Focus models have been registered in the UK. Ford was the best selling manufacturer in 2007, although Audi, Honda, Mini and Vauxhall showed some of the most improved performances of the year.
All segments bar the mini, upper medium and luxury saloons posted improved volumes in 2007. The MPV market showed the best growth, up 16.5%. Supermini volumes were up 17,729 units, but the lower medium segment posted the biggest rise - up 25,084 units.
Sue Robinson, director of the RMI’s National Franchised Dealers Association (NFDA), said: "The increase in new car sales in 2007 shows that consumer confidence weathered the economic storms, but interest rates must come down in 2008 for this level of demand to continue."
Robinson believes that the uncertain economic situation and increasing environmental awareness will inform car-buying choices in 2008: "Smaller family cars and superminis will be high on the agenda as families look for vehicles which are more economical to run and are more positive for the environment."
Robinson added: "Rising household costs will have an impact on other major purchases, so the Government and the Bank of England needs to help balance the situation through maintaining lower interest rates."
New car registrations
Registrations by sales type
Top 10 best sellers