National Institute forecasts rate rise before year end

Biggest rise in factory output since November adds to hopes of recovery in the beleaguered manufacturing sector

The Bank of England will have to raise interest rates as soon as November, one of the country's leading think tanks warned yesterday.

The bullish forecast by the National Institute of Economic and Social Research came as official figures added to hopes of a recovery in the beleaguered manufacturing sector.

The institute's latest estimate of economic growth showed a marked acceleration over the last two months.

It said the economy grew 0.8 per cent in the three months to August, more than double the rate seen in the second quarter of the year.

Martin Weale, the NIESR's director, said: "The strength of the recovery has been greater than we expected so far and makes an interest rate rise likely this autumn."

He said if official estimates of third-quarter growth published in late October chimed with the institute's, the Bank should look to raise rates in November - the first move for almost four years.

This is in line with the financial markets, which have priced in a rate rise in the wake of a string of upbeat figures on house prices, consumer borrowing, engineering, construction and the services sector.

A key element in the institute's estimate was a meaty 1 per cent rise in the industrial sector - its biggest quarterly growth in exactly three years.

This in turn coincided with official figures showing that factories hiked their prices last month following a marked acceleration in output. Factory output jumped by 0.5 per cent in July thanks to a near-9 per cent surge in the manufacture of computers, the Office for National Statistics said.

It was the second consecutive rise in manufacturing activity and was the strongest since November last year.

According to separate figures published yesterday a key measure of industrial inflation showed manufacturers imposed their biggest price rises for seven years.

Prices for goods apart from the volatile food, drink, petrol and tobacco products rose by 1.5 per cent compared with a year earlier, the steepest annual rate since July 1996.

Taken together, the figures added to market speculation that the next move in interest rates would be up. Adam Cole, a senior economist at Credit Agricole, said: "The main debate on the Monetary Policy Committee will soon be the timing of the first rate hike."

Mr Cole said the manufacturing figures pointed to a good start for the third quarter of the year. "With global activity strengthening, the outlook for the coming months is more encouraging," he said.

The ONS said it had raised its trend forecast for manufacturing from zero to annual growth of 1 per cent, the strongest trend rate of growth since January 2001.

However, away from the surge in computer manufacturing and a strong performance from the machine tools sector, the rest of manufacturing was either flat or down. Mark Williams, the ONS' manufacturing statistician, said: "It is still a relatively flat picture."

Certainly the industry trade bodies are not banging the drum for a pronounced and guaranteed revival in manufacturing. The Engineering Employers' Federation has issued an upbeat forecast for a return to growth over the next three years but tinges this with caution.

Stephen Radley, the EEF's chief economist, said: "It is a natural upturn from the severe falls over the last few years."

David Kern, chief economic adviser to the British Chambers of Commerce, agreed saying the sector was staging a "welcome but fragile upturn after a deep and prolonged recession".

He added: "The recovery is not yet secure and firmly based, and still faces many hazards."

The BCC forecasts that manufacturing will register a minimal rise in 2003 as a whole, and then grow by only 2 per cent in 2004.

One mystery is the failure of increases in output to be accompanied by a surge in investment that one would have expected if companies were preparing for a major upturn.

The latest official figures show investment has collapsed to its lowest level in more than five years. In both of the previous manufacturing recoveries in 1983 and 1993, investment had started to rise at this stage in the cycle. Mr Radley said: "What is encouraging from today's figures are that the two sectors that make investment goods - machine tools and electronics - are both seeing output increasing.

"But the picture is still very patchy. Customers are purchasing computers because they can't postpone those decisions for ever."

Despite the rush in the City to bet on a rate rise, many economists at banks in the Square Mile said it was too early to celebrate a manufacturing rebound.

Richard Iley, UK economist at BNP Paribas, said: "Question marks remain over the durability of any upswing in the manufacturing sector."

He said that with a third of manufacturing products destined for export, the sector's health was dependent on continued recovery in the US and a rebound in the stagnant eurozone economy.

"Hard evidence of a sustained upturn in eurozone final demand remains the sine qua non for a durable recovery in UK manufacturing," he said.

Simon Rubinsohn, chief economist at Gerrard stockbrokers, added that policy will remain on hold for some time.

But whether the latest upturn is a temporary blip or the start of something more -significant, few people believe it will halt a long-term decline in British manufacturing.

Just after World War Two, manufacturing accounted for almost 40 per cent of the UK economy whereas it now contributes just 22 per cent of national wealth.

At the end of the 1970s, it employed just under a third of the total UK workforce but it has now fallen to a fresh all-time low of 3.51 million people in June, and is declining at a rate of 130,000 a year.

The sector has been hit by a triple whammy. The strength of the pound between 1996 and last year made British exports expensive.

Meanwhile, traditional manufacturing - everything from clothing to metal bashing - has been hit by low-wage competition from Eastern Europe, the Far East and now China.

Finally, its one recent success story - the telecoms and technology sector - was brought to its knees by the bursting of the IT bubble three years ago.

If the current rate of job losses were to continue there would not be anyone employed in manufacturing within a quarter of a century.