City expects rate rise this year

The City was last night betting on at least one increase in interest rates before the end of the year after a strong performance by the service sector raised the prospect of anti-inflationary action from the Bank of England.

Despite leaving the cost of borrowing unchanged for the ninth successive month, the best performance by the service sector in more than two years prompted speculation that the monetary policy committee would soon be forced to raise rates. Money markets were signalling rates of between 4.75% and 5% by the end of 2006 compared with the current level of 4.5%. Upbeat economic data this month, culminating in yesterday's survey of the service sector from the Chartered Institute of Purchasing and Supply, prompted analysts to suggest there was an increased chance of tightening of policy.

The CIPS index of business activity in the service sector rose from 57.4 in March to 59.7 last month - with new orders, employment and prices increasing at a more rapid rate. Any finding above 50 on the index shows that the sector is expanding.

Robert Barrie, UK economist at Credit Suisse First Boston, said the only way for rates to go was up. "The fourth quarter probably looks like the most likely time, but we wouldn't rule out something slightly sooner than that. Our policy rate assumption for the end of this year goes to 4.75% from 4.50%. The assumption for the end of next year is now 5.25%."

TUC chief economist Ian Brinkley said: "The Bank has made the correct decision. Manufacturing has enjoyed some positive news in recent days, after months of difficulty. It is far too early to put this upturn at risk with a rise in rates."

CBI chief economic adviser Ian McCafferty said: "While we are not surprised by the MPC decision, we are slightly disappointed. We believe inflationary pressures remain under control, and the economic outlook is sufficiently fragile to permit a small cut in rates."