Buoyant Britain's rates set to rise

A buoyant Christmas on Britain's high streets has helped boost economic growth to a three-year high, sealing the fate of the country's homeowners, who face a rise in borrowing costs within weeks.

Dire predictions of a gloomy holiday season proved wide of the mark when official figures were released yesterday morning. The Office for National Statistics said retail sales volumes rose by 0.9% last month, the sharpest monthly increase since May 2002.

The unexpected strength of sales contributed to a surge in output in the final three months of the year, the ONS said. Output rose by some 0.9% over the quarter, the highest increase since the first quarter of 2000.

The acceleration in growth in the final quarter meant the economy expanded by a respectable 2.1% in 2003 as a whole, just a notch above the 2% growth pencilled in by the chancellor in last month's pre-budget report and up from 1.7% recorded in 2002.

"Even sterling's renewed rise is unlikely to stand in the way of a rate rise after these data," said Ross Walker at the Royal Bank of Scotland.

Threadneedle Street was the first major central bank to respond to the global upturn with higher rates when it pushed up borrowing costs by a quarter of a percentage point in November. City analysts are now pencilling in a repeat quarter-point increase when the Bank's monetary policy committee meets the week af ter next. The market expects borrowing costs to rise from the present level of 3.75% to 4.75% by the end of the year.

The prospect of higher returns boosted sterling, which briefly jumped above $1.85, within a cent of last week's 11-year high, before easing back to $1.8325 in late trading.

Ed Balls, the Treasury's chief economic adviser, dropped a clear hint last night that the government backed the case for dearer borrowing. "We have backed the MPC in the decisions it has taken to lock in stability as the economy strengthens,"he said in a speech at York University in which he dismissed concerns about the health of the public finances.

But the shadow chancellor, Oliver Letwin, said the Treasury's coffers ought to be in better shape, considering the strength of the upturn in the economy. "This reinforces the need for the chancellor to explain why, when the economy is roughly in line with his own predictions, he is borrowing so much more than he forecast," he said.

Mr Balls also made it clear that Britain would not reconsider its decision to join to the euro until Europe finished modernising its fiscal rulebook. "The future evolution of the stability and growth pact is of crucial importance," he said.

Retailers slashed prices to persuade bargain-hunting shoppers to part with their cash, the ONS said.

Industry made no contribution at all to growth over the quarter, with the pace being set by service sector firms.