Eddie George worried over windfalls

Eddie George said yesterday he was concerned about the potential inflationary pressures from recent building society windfalls. Speaking on the day before the first monthly meeting of the Bank of England's newly appointed monetary policy committee, the Governor warned that the estimated pounds 30bn of handouts from the flotations represented a significant boost to domestic spending.

His caution, coupled with a survey showing an eleventh consecutive rise in trading conditions in the service sector, had analysts predicting a quarter point rise in interest rates would be announced tomorrow. A two- day meeting of the monetary policy committee starts today, its first since Gordon Brown gave the Bank operational independence to set interest rates.

Simon Briscoe, economist at Nikko Europe, said: "This survey confirms what we already knew, that the service sector continues to grow strongly. The strength of the survey will increase expectations that the new monetary committee will tighten policy at this week's meeting."

The UK Purchasing Managers Report on Services, published by the Chartered Institute of Purchasing and Supply (CIPS), showed companies experiencing higher demand both at home and overseas. Employment in the service sector, which already accounts for three-quarters of all British jobs, grew sharply in May and severe skills shortages started to emerge.

According to CIPS, rising payrolls have not kept pace with outstanding work, with many companies saying they did not have the capacity to meet the growth in demand. Higher salary levels needed to retain staff and attract new recruits also led to a rise in costs in May.

There was some good news on the inflation front, however. While some businesses had been able to pass on higher input prices, competition meant many others were unable to charge higher prices.

Peter Thomson, director general of CIPS, said: "Growth on this scale in the UK service sector beats anything we have seen lately in manufacturing. Service companies do seem to be suffering from skill shortages, which are driving up their costs. Though there is certainly a developing trend of firms passing on these costs to their customers, inflationary pressures are being subdued by competition."

Mr George sent a tremor through foreign exchange markets when he appeared to be talking down the pound as he commented on the complications of setting interest policy. He said the new monetary policy committee would discuss the contradictions in setting policy against a background of rising consumer demand, which might require higher rates, and a strong pound, which would be exacerbated by an increase.

He said: "The immediate problem is to balance the degree of tension between the pressure of domestic demand, which has been running a bit above a sustainable rate, with the exaggerated strength of the exchange rate." The pound fell almost 2 pfennigs to below 2.82 marks at one stage after earlier reaching a fresh four-and-a-half year high of 2.8331 marks.

Bonds also suffered. On Liffe, the September gilt futures contract was 11/32 lower at 11312/32, while the September short sterling futures contract was 0.04 lower at 93.16.