Buoyant Economy Fuels Fears Of Interest Rate Rise

The threat of a new rise in interest rates as soon as next month rose sharply yesterday after buoyant figures showed soaring activity in the services sector, record company profitability and the housing market “mini-boom” continuing from last year.

As the Bank of England’s Monetary Policy Committee (MPC) prepares to gather tomorrow for the first time this year, ahead of next week’s January base-rate verdict, the spate of news suggesting the economy had begun the new year in rude health fuelled City speculation over a February rate rise.

The services sector, the engine-room of the economy, roared into 2007, with activity during December at its strongest in nearly a decade, according to the latest gauge of conditions in the CIPS/RBS purchasing managers’ survey.

The survey’s headline index rose to 60.6 for last month, its highest since June 1997, and up from 59.8 in November.

Services companies emerged from the CIPS survey as the most optimistic over future prospects since January 2004.

The Bank will also be concerned that the pace of job creation by the services sector accelerated last month to its fastest pace since August 1997 — a development that could stoke upward pressures on wages, the MPC’s chief concern over inflation in coming months.

Those worries among the rate-setting committee will be heightened by a report yesterday from Incomes Data Services (IDS), the pay consultancy, that rising inflation appears to be fuelling higher pay settlements.

January wage deals recorded so far by IDS are running at an average level of 4 per cent — up from a figure of 3 per cent in the final quarter of last year.

The Bank’s own upbeat prognosis for the economy was bolstered, meanwhile, by official figures that showed record corporate profitability outside the financial sector.

Booming returns on companies’ capital investments should encourage them to step up the pace of future investment, further boosting growth across the economy.

Measured by the so-called “net rate of return” on capital, profitability at non-financial companies climbed to levels above 15 per cent for the first time during the third quarter of last year, hitting 15.2 per cent, against 14.9 per cent in the second quarter.

Profitability in the battered manufacturing sector picked up, with a net rate of return of 7.2 per cent in the three months to September, against 6.3 per cent in the previous quarter.

But there remained a wide gap with the services sector, where returns were running at 15.2 per cent in the third quarter, up from 14.9 per cent previously.

Profitability at oil companies, where record crude prices have boosted earnings, slipped back in the third quarter, to 42.9 per cent, down from 47.6 per cent in the previous three months.

A further gathering of steam in the housing market, where conditions seem unchecked by the Bank’s two rate rises last year, will provide more ammunition for hawks on the MPC with fingers itching over the interest rate trigger.

Net mortgage borrowing rose by £9.8 billion in November, marking the largest rise in cash terms since September 2003.

Evidence that the resurgence in the housing market last year will persist into this year was further reinforced by strong mortgage approvals. The overall number of new home loans approved rose by 5 per cent in November, compared with the previous month, to a three-year high of 320,000.

The approvals data were flattered, however, by hefty levels of remortgaging activity on existing homes, with approvals of new loans for house purchase rising much more modestly to 129,000 in November.

Amid the spate of robust data there was little to back the case of any MPC doves. But economists pointed to a surprise retreat in confidence among consumers amid a substantial toll on spending power from higher taxes and utilities bills.

The headline index in the regular snapshot of consumer sentiment from GfK fell to minus 8 for last month, from a November reading of minus 7.

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