Industrial resurgence cuts odds on rates rising

BUSINESSES and consumers face the prospect of higher interest rates this year after the manufacturing sector notched up its strongest performance in more than 16 years while firms' costs rose at a record pace.

The continuing resilience of industrial companies will be welcomed by the coalition government, which is relying on the private sector to sustain the economic recovery at a time of deep public-spending cuts.

However, accelerating cost pressures will be less welcome, with consumer price inflation already more than a percentage point above the Bank of England's 2 per cent target.

The Chartered Institute of Purchasing & Supply's (Cips) manufacturing purchasing managers' index jumped to 58.3 in December, up from 57.5 a month earlier, driven by strong orders from overseas. It marks the highest reading since September 1994.

The activity index has been above the 50 mark separating growth from contraction since the middle of 2009.

But on the day that VAT increased to 20 per cent, the sector yesterday delivered fresh warnings that more price rises are in the pipeline after input costs rose at their fastest in the 19-year history of the survey.

The steepest price hikes were reported in the textiles, clothing, food, drink, chemicals and plastics sectors.

Rob Dobson, senior economist at Markit, which produces the purchasing managers' reports alongside Cips, said: "The UK manufacturing sector saw a truly spectacular end to 2010.

"The latest data are consistent with manufacturing production rising at a quarterly rate close to 2 per cent, which should generate a meaningful contribution from the sector to economic growth in the fourth quarter to offset likely weakness in other sectors."

Howard Archer, chief UK economist at IHS Global Insight, the forecasting group, said healthy orders growth last month "bodes well for manufacturing output in the early months of 2011 at least".

He added: "The only real blot in the survey was the record rise in input prices, which led to a pick-up in output prices.

"This will not go down well at the Bank of England, and it will fuel speculation that the monetary policy committee could be pressurised into raising interest rates earlier than they would like given the headwinds facing the economy."

The input cost hikes, caused by strong demand and rising energy costs, are a worrying sign. Price rises have already been passed on to manufacturers' customers, with selling prices now stronger for the past 13 months.

However, James Knightley, an economist at ING Bank, believes the relative weakness of the UK economy will make it unlikely that the central bank will raise interest rates soon.

"With domestic demand set to be hit by tight credit conditions, higher VAT, government spending cuts, negative real wage growth and falling house prices, we still feel that the Bank of England will want to wait as long as possible to ensure the recovery continues," he said.

l Firms are concerned about their prospects for the coming months and plan to freeze investment and raise prices, a report by Lloyds TSB said yesterday. Business confidence slipped back for the first time in 18 months.