Interest rate jitters spark heavy shares sell-off on London market

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Fears of another unexpected increase in interest rates at noon today sparked a sell-off on the London stock market yesterday, with £12.7bn wiped off the value of the FTSE 100.

A jump in prices on the high street and a third consecutive month of growth in manufacturing figures published yesterday added to the nerves.

"Unchanged interest rates seem a pretty safe bet [today] although we admit that we would have lost such a bet in August," Howard Archer, UK economist at Global Insight, said.

However, all 54 analysts polled by Reuters said the Bank of England would keep its powder dry today, with 40 saying its Monetary Policy Committee would wait until November to raise the base rate to 5 per cent.

Yesterday, official figures showed factory output rose 0.2 per cent in July. The chemicals industry made the largest contribution with a 3.7 per cent surge in pharmaceuticals to a record level.

Analysts said continued growth was encouraging but not spectacular. "Increasingly, it looks like the opportunity for a substantial manufacturing recovery looks to have passed," John Butler, the chief UK economist at HSBC, said.

Shop prices rose last month at their fastest rate in more than two years, according to a British Retail Consortium survey.

The BRC said its August shop prices index was up 1.4 per cent compared with a year ago, an acceleration from July's 0.69 per cent increase and the fastest rate since May 2004. Heavy discounting in August last year boosted the annual comparison, the BRC said.

The National Institute of Economic and Social Research, an independent think-tank, said its projections showed the economy grew 0.8 per cent in the three months to August, well above the accepted trend rate of about 0.65 per cent.

Martin Weale, its director, said: "GDP continues to grow above trend. It is likely that there will be a need for further interest rate rises."

The FTSE 100 index of leading shares fell 52 points, or 0.9 per cent, to 5929.3. "The Bank raising interest rates may still be unlikely to happen, but it has depressed the market and people are worrying about it," a trader said.

Analysts agree the likelihood and timing of any rate rise would depend on the data over the next two months and the MPC's attitude towards rising inflation.

"As the MPC meet in November, they will expect that inflation is likely to run near 3 per cent well into the second quarter of 2007," Malcolm Barr, the UK economist at JP Morgan, said.

"The prospect of a move up in rates in November reflects the MPC's desire to ensure a higher level of inflation does not get embedded in the system, rather than the contemporaneous strength of growth."

Meanwhile there was fresh evidence of the downside risks to growth from a survey showing that optimism among consumer services firms had slumped.

The CBI's survey of 135 firms showed the turnover of firms dealing directly with consumers had suffered their sharpest fall since the aftermath of the September 11 terrorist attacks. It said rising household bills and fears of rate rises had led consumers to spend less on social activities over the latest three months.

It contrasted with professional services firms that grew faster than expected and separate figures pointing to healthy conditions on the high street.