UK interest rates expected to rise

A strengthening recovery in the UK manufacturing sector and a surge in retail sales today reinforced the case for higher interest rates when the Bank of England meets later this week.

The Bank's monetary policy committee (MPC) is already widely expected to raise the cost of borrowing on Thursday, its first upward move in over three years.

Today's double dose of strong economic news, coming on top of recent data showing record consumer borrowing and renewed momentum in house prices, all but ensured that a rate rise is a done deal.

Some analysts even think the MPC will lift borrowing costs by as much as 0.5% from the current 48-year low of 3.5%, although the majority opinion is a smaller 0.25% increase.

Today's CIPS survey showed Britain's manufacturing sector expanding at its strongest rate in almost four years. The institute's purchasing managers' index (PMI) for manufacturing rose to 54.2 in October, the strongest figure since December 1999, and up from an upwardly-revised 53.2 in September. A score above 50 represents expansion while below that level signals contraction.

An expansion in output and new orders accounted for the improvement in manufacturing, only now beginning to recover from its worst slump in 10 years. Firms reported strong demand from overseas, particularly the US, but also noted growth in Germany, east Asia and Ireland. Earlier, another survey showed that growth in the eurozone's manufacturing sector picked up speed in October.

Strong demand from overseas pushed down UK stock levels in October, despite increased production and companies' efforts to build up stocks in anticipation of even higher demand in the future.

The PMI survey in the eurozone registered a 15-month high of 51.3 in October, up from 50.1 a month before. France produced the most significant turnaround.

After a disappointing 48.6 in September, strengthening new orders and production growth led to the first expansion of the French manufacturing sector in eight months, with a reading of 51. In Germany, new export orders drove overall recovery, leading to a rise of the PMI index to 51.2, up from 50.2 in September.

The encouraging surveys followed last week's data from the US, which showed the world's largest economy accelerating at a tremendous pace in the third quarter. The US economy grew at an annual rate of 7.2% in the July-September period, far surpassing expectations.

"Today's news is likely to lift the UK and European stock markets," said Andrij Halushka, economist with the Centre for Economics and Business Research. "Another consequence of today's news, together with the new US data, is an increased probability of a decision to raise interest rates at the MPC meeting, as a weak eurozone economy was one of the worries during the October meeting that helped to keep interest rates on hold."

Meanwhile a survey from the CBI, the employers' organisation, showed that retail sales in October rose at their fastest yearly rate for 18 months.

According to the latest monthly distributive trades survey published by the CBI, sales grew in September but by less than had been expected. But October's performance was much stronger and outstripped expectations.

21% of retailers said sales were down compared with October last year but 56% said they were up. The positive balance of 35% represented the fastest rate of growth since April 2002.

On interest rates, the CBI said the pickup in demand strengthened the case for a reversal of the precautionary cut made by the Bank in July. But the CBI cautioned against an overly aggressive move towards higher rates.

"The recent recovery in the wider UK economy is in its early stages and is still fragile," Ian McCafferty, CBI chief economic adviser, said. "The Bank needs to ensure that it does not damage business confidence with a series of quick rate rises. The MPC must make clear that in the coming months it will not choke off a recovery that has still not fully taken hold."