Rate cut unlikely after services rally

The prospects of an interest rate cut dimmed today as the key services sector was shown to have expanded for the second month running in May.

Service sector firms - which account for two-thirds of the economy - appeared to have regained their confidence following the end of the war in Iraq, with optimism rising to its highest level since last September, a survey from the Chartered Institute of Purchasing and Supply (CIPS) reported.

CIPS said that its activity index rose to 51.9 from 50.7 in April - the highest since January and above the average City forecast of 51.1. But the CIPS survey cautioned that the index was still only slightly over the 50 "no-change" mark that divides expansion from contraction.

"Modest activity growth in May generally reflected rises in general business sentiment due to the end of hostilities in Iraq and ... the return to growth of levels of incoming new business," the report said.

Notwithstanding the improvement, growth remained well below the average for 2002.

"Despite the increase in sales, latest survey data suggest that capacity levels in the UK services sector remained under little pressure in May," CIPS said.

Today's report was slightly more upbeat than Monday's snapshot from the Confederation of British Industry (CBI), which said that service firms faced a "tortuous and protracted" road to recovery. The CBI survey said that firms' expectations about output in the year ahead crashed to their lowest level since the survey began four years ago.

Most economists think the Bank of England's monetary policy committee (MPC) will keep rates unchanged at 3.75% tomorrow, although many think it will be another close vote. Last month, four of the MPC's nine members voted for a cut and only the governor's decision to back the status quo kept rates on hold. This will be Sir Eddie George's last meeting as governor with Mervyn King, the deputy governor, taking over.

In another survey, this time from the CBI, conditions on UK high streets improved but retail sales growth was modest compared with last year.

Retail sales were higher in May than a year earlier, the second consecutive month of year-on-year growth, following a difficult start to 2003 when sales barely grew at all, the latest CBI retail survey reported.

For the second month in a row sales growth was better than forecast, and it is expected to be slightly stronger in June. But while sales growth was better than in the first quarter of 2003, it was well below the rates of growth seen last year and longer term averages, the CBI said.

Alastair Eperon, chairman of the CBI's distributive trades panel and a director of Boots, said: "Spending over the past couple of months has been boosted by the good weather, low unemployment, the end of the Iraq conflict and the prospect of another rate cut. The underlying trend is creeping back up but it is still well down on the growth seen through most of 2002."