Inflation worries put pay to cut in rates next month

Hopes of a February cut in UK interest rates were finally killed off yesterday as the economy accelerated and the Bank of England said it was still worried about inflation.

The economy grew 0.6 per cent in the final three months of 2005, up from 0.4 per cent in the previous quarter. This was ahead of market forecasts and the strongest pace for a year, figures showed.

Despite the rebound, annual growth came in at 1.8 per cent, the slowest since 1992, while strong growth in China confirmed the world's most populous economy had overtaken the UK in the global league table.

Figures from the Office for National Statistics showed robust growth among services firms had outweighed a sharp fall in manufacturing output.

The services sector, which makes up three-quarters of the economy, grew 0.9 per cent. Retail, transport and business services subsectorsposted growth of more than 1 per cent. Factory output fell 0.8 per cent.

Growth in government and other services slowed to 0.5 per cent from the 0.8 per cent quarterly growth seen in the rest of 2005 - its weakest in more than a year. The headline figure pushed the pound to a four-year high against the dollar as traders pulled out of bets that the Bank was poised to cut rates.

"A rate cut in February is practically ruled out," said Nick Stamenkovic, at the bond brokers RIA, who has put back the timing of the first rate cut to May.

The message was reinforced by the minutes of this month's meeting of the Bank's Monetary Policy Committee, which showed it voted eight-one to keep rates on hold for the second month in a row. Stephen Nickell was again the lone dissenter, and the minutes showed his arguments failed to sway any of his colleagues.

The London School of Economics professor said the Bank's forecast for investment and trade looked too optimistic, while unemployment figures showed there was spare capacity in the economy. "It seemed likely that inflation would fall below the target once the effects of higher energy prices had dropped out of the [annual] calculations," he said.

But the majority said growth in services output, the housing market and share prices would keep growth in line with its trend rate. "In the short term, upside risks to inflation from higher oil remained and there were uncertainties surrounding the likely evolution of import prices and the exchange rate, which were important influences on the outlook for inflation," they said.