Rate threat to homeowners

Speculation was growing in the City last night of the base rate rising to 5% within the next six weeks after news that last month was British factories' best for a decade.

The signs that the long-suffering manufacturing sector was finally on the mend convinced some analysts that the Bank of England might be tempted to raise the interest rate by half a point this week for the first time since it became independent in 1997.

The majority believe that the Bank's monetary policy committee (MPC) will stick to raising the rate in quarter point steps but the unexpected strength of manufacturing has prompted talk of back-to-back increases this month and next.

Yesterday's snapshot of industry, by the Chartered Institute of Purchasing and Supply, showed that after a prolonged period of weakness under Labour, in which 750,000 jobs have been lost, strong demand at home and in world markets enabled industry to perform strongly last month.

The CIPS's purchasing managers' index (PMI) - a composite measure covering everything from new orders and output to prices and jobs - unexpectedly jumped to 56.3 last month from an upwardly revised 55.0 in June to give its highest reading since October 1994.

"This was a phenomenally strong manufacturing PMI ... the evidence indicates that the recovery is spreading to the parts normal recoveries do not reach," said Ciaran Barr, an economist at Deutsche Bank in London. "Today's report ... raises the possibility that the Bank discusses a more aggressive half-point move on Thursday." But, he added, he still thought a quarter point increase more likely.

Paul Dales, an analyst with Capital Economics, said: "We still believe that the MPC will raise interest rates [by a quarter point] on Thursday, but it is becoming increasing likely that rates will rise next as early as September's meeting."

The Bank of England has long been expected to increase its base rate by a quarter point to 4.75% this week, but last week's strong house price report from the Nationwide, together with booming retail sales and the fastest economic growth for four years, has prompted some economists to suggest that the MPC will take tougher action to cool down the economy.

The Bank's chief economist, Charles Bean, said last week that it did not want to "clobber" the British consumer, who had kept the economy afloat during the recent years of manufacturing recession.

And several economists said yesterday that the manufacturing data were not always a reliable guide to the official industrial output figure, as they often overstated it.

John Butler at HSBC noted that the latest survey conflicted with a similar report from the CBI last week which reported a slackening of activity in the three months to July, rather than a pick-up.

Nevertheless he said: "The market is firmly looking for an increase in base rates at the MPC meeting on Thursday, and if the optimism in the PMI survey is finally supported by the production numbers themselves, then this will only add to the case for further rate rises."

The financial markets are pricing-in interest rates above 5% by the end of the year and peaking around 5.5% in the middle of next year, sharply up from the 48-year low of 3.5% seen last year.

Similar PMI releases on other major world economies yesterday produced fewer surprises. The euro zone index rose slightly to 54.7, driven by overseas rather than domestic demand.

The rise was expected and analysts said it would have no influence on the deliberations of the European Central Bank, which has kept its rate at 2% in an effort to boost the zone's economy.

In the US the ISM manufacturing index rose to 62.0, bang in line with expectations, from 61.1 in June. Markets expect the Federal Reserve to raise the interest rate this month by another quarter point to 1.5%.

Oil prices reached a fresh record as the US government warned of terrorist threats against the financial sector in New York and Washington.

US light crude futures set a new high of $43.92 a barrel in early dealing before slipping back to $43.35 later in the day. Brent crude briefly topped the key $40 a barrel mark although later it too dipped back.