Factory output grows at fastest rate for two years

Britain's manufacturing recovery gathered strength last month with surging domestic demand and reviving export orders generating the fastest pace of expansion for nearly two years, according to a survey published yesterday.

With output growth led by investment goods such as plant and machinery, there was hope that the sector's improvement could be sustained by the installation of new capacity.

But some economists said manufacturing could be set back again if the renewed strength of the pound choked off the still fragile growth of exports.

The survey left City analysts divided over the outcome of next week's interest rate meeting at the Bank of England.

While most thought the disinflationary impact of the pound's strength would persuade the bank's monetary policy committee to leave rates on hold, at 5.25%, a minority said a second quarter-point increase in borrowing costs was likely to safeguard the government's 2.5% inflation target.

"Given the resurgence in both the British and global economies the stance of UK monetary policy is now too loose, and rates need to rise again if inflation is not to become a problem in one to two years' time," said Philip Shaw, chief economist of Investec.

The monthly manufacturing snapshot by the Chartered Institute of Purchasing & Supply showed output and orders rising for the sixth month in September, prompting the fastest rise in overall activity since November 1997.

Roy Aliffe, a director at CIPS, was particularly encouraged by growth in the investment goods sector, where output increased at its fastest rate for almost 2 years.

"This shows there is more confidence in the manufacturing sector to invest in further production methods," he said.

The strength of demand and emerging supply bottlenecks allowed firms to raise prices for the second month, fuelling worries about higher inflation.

But continued cost-cutting led to a further reduction in employment, with jobs being shed for the 18th successive month - albeit it at a decelerating rate.

The improving health of the global economy was also felt in Europe last month, with eurozone manufacturing activity rising at its briskest pace for 14 months, according to a separate survey published by Reuters news agency.

Signs of mounting price pressures and hawkish comments from officials at the European Central Bank suggested that the ECB might also raise interest rates at its next meeting, said analysts.