Manufacturing at 16-year high even as costs head higher

December's exceptionally cold weather failed to cool the enthusiasm of Britain's manufacturers, who ended 2010 in their most upbeat mood in 16 years.

The Chartered Institute for Purchasing and Supply says that output, new orders and exports all displayed strong positive trends last month – but there is increasing evidence that the boom in global commodity prices is starting to push input costs higher, with some of the rise now being passed through to consumers. That news will be problematic for Bank of England policy makers, who will also have seen the latest readings on inflationary expectations yesterday, also sharply higher.

Taken together, the latest data will add to the pressure on the Bank's Monetary Policy Committee to raise rates sooner rather than later, if only by a token amount.

The Cips, representing many thousands of industrial managers, said that December saw the headline reading for business optimism in the sector rise to 58.3, up on the 57.5 seen in November – the 17th successive month that the number has been above the neutral 50 mark.

As evidence of the much-vaunted rebalancing of the British economy, this latter-day industrial revival will be especially welcome to ministers. However, some economists suggest that the expansion is not strong enough, nor the manufacturing sector large enough, to generate sufficient jobs to compensate for those due to be lost in the public sector; manufacturing accounts for about 12 per cent of the economy. Still, output and new orders rose at their fastest rates since May, and jobs growth remained close to the November's survey record rate. Had the snow not disrupted supply chains and deliveries, the data might have been even stronger, said the Cips.

David Noble, Cips' chief executive, said: "The start of 2011 is likely to be 'all systems go' for UK manufacturing, demonstrating a huge turnaround of fortunes compared with two years ago. The accelerated growth of new orders in export markets and recent record rates of increase in manufacturing jobs are a positive end to the year. They also bode well for a continuation of the manufacturing-led economic recovery next year."

The renaissance was led by "substantial" rates of growth in the electrical, vehicle, chemicals and plastics sub-sectors. New export orders rose at the fastest pace since April's record high, reflecting increased sales to clients in mainland Europe, the US and Asia.

But reflecting world developments, there was steep cost inflation in textiles, clothing, food and drink and the chemicals and plastics groups. Overall, input prices are rising at their steepest rate since 1992, and faster than before the last commodity price spike in 2008. Already visible in the high street, even before the hike in VAT to 20 per cent this week, these developments seem to be shifting public expectations of inflation some way beyond the official 2 per cent target, as prolonged experience of inflation at variance with the target grows. Much of the current inflation is also concentrated on high profile "everyday" items such as food, petrol and rail tickets, which tends to amplify public perceptions.

The latest YouGov survey of inflation expectations among the public for December shows them up to an annual rate of 3.5 per cent, up from 3 per cent in October. The Bank forecasts 3 per cent inflation, or more, for the whole of this year. Given the latest trends, it may have to revise that figure still higher for the next Inflation Report, in February, and that may foreshadow higher rates. Much will depend on whether wage pressures start to intensify.

DeAnne Julius, the former MPC member who is now chairman of Chatham House, said of the Bank's record: "It is surprising to me that only one MPC member is concerned enough about persistently overshooting inflation – in the face of sustained growth – to vote for a rise in interest rates."