Booming services set to force rate hike

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Service industries are enjoying near-boom conditions but manufacturing at best limped along in the second quarter of the year, according to new figures yesterday.

With services making up two-thirds of the economy, most analysts expect the Bank of England to announce an increase in interest rates tomorrow by a quarter of a percentage point to 7 per cent.

The prospect of another increase in the cost of borrowing combined with an assault on the German mark by the currency markets to take the pound to DM3.06 yesterday, its highest for more than seven years. On the stock market, the FTSE100 index powered ahead by 64.9 points to 4,960.6.

Official figures yesterday showed that manufacturing output expanded by 0.4 per cent in June to a level just 1.2 per cent higher than a year earlier.

In the latest quarter there were increases in production of mineral products, transport equipment and electrical equipment but big falls in machinery, textiles and clothing and chemicals. Total manufacturing shrank by 0.1 per cent in the second quarter.

A regional breakdown by the Confederation of British Industry and Business Strategies showed that manufacturing output has boomed in East Anglia and Northern Ireland during the past four months, and expanded in four other regions. But it fell sharply in Wales and declined slightly in four other areas.

Adding in a big rise in the energy sector helped take total industrial production up 1.4 per cent during the month, but only 0.4 per cent in the three months to June.

The prospect that growth in industry is crawling to a halt prompted warnings from some economists that the strong pound means no more interest rate increases are needed. "The Monetary Policy Committee needs to tread very carefully if it is to avoid tipping industry back into recession," said Jonathan Loynes at HSBC Markets.

However, other experts pointed to the evidence of rapid growth in services, confirmed by a survey from the Chartered Institute of Purchasing and Supply yesterday. This showed that the pace of growth slowed between June and July, but the index of actvity remained, at 62.1, well above the 50 watershed between boom and recession.

Expectations of a rise in interest rates boosted the pound yesterday. But sterling was also riding on the coat-tails of a decline in the mark against the dollar. Comments by Bundesbank officials, in a bid to stop the German currency falling too far too fast, were taken as a challenge by traders.

"The Germans have used verbal intervention, but the markets are now looking for action," said Nick Stamenkovic of DKB.

All eyes will be on the Bundesbank's decision whether or not to opt for a variable rather than a fixed interest rate when it announces the terms of next week's repurchase agreement, the means by which it acts in the money markets. For the first time it is hinting at the possibility of increases in German interest rates.

But most analysts think this step is some way off. Alison Cottrell at Paine Webber said: "They will use all their verbal firepower first before turning to the interest rate blunderbuss. The German economy does not need higher rates."