Services boom could tip knife-edge rate decision

There was new evidence yesterday that service industries are still booming. It came as the Bank of England's Monetary Policy Committee started wrestling with the question of whether to raise interest rates this week. Diane Coyle, Economics Editor, reports on the knife-edge decision.

The vast majority of City pundits expect the MPC to cheer home-buyers by leaving the cost of borrowing unchanged at 7.25 per cent today. But the closeness of the call was highlighted by a new survey suggesting that activity in the service industries, which make up two-thirds of the economy, grew even faster in January.

The Chartered Institute of Purchasing and Supply, which surveys purchasing managers each month, reported a rise in its activity index from 57.6 in December to 58.6 in January. This reflected very strong employment growth, which allowed companies to expand capacity and cut down on their backlog of work.

The report commented: "Increased demand for suitable staff again led to a further rise in wages and salaries in January."

Peter Thomson, director general, added: "There are no significant signs of growth slowing."

However, business optimism did decline during the month, falling to the lowest level since the survey began 19 months ago.

In addition, stiff competition meant that only 8 per cent of the companies surveyed were able to increase the prices they charged customers. "The outlook for inflation is better than it was last year," Mr Thomson said. In addition, the rate at which new business grew slowed down compared to December.

The results of the survey - which is relatively new and untested but is also one of the few available indicators of what is going on in services as opposed to manufacturing - left analysts divided about how fast the economy will slow this year. For the contrast between service industries enjoying boom conditions and manufacturing flirting with outright recession could scarcely be greater.

David Hillier at Barclays Capital said the MPC should raise rates this week as an insurance policy against the remaining inflationary dangers. "One more rise would send a clear message to employers and employees at a vital time in the pay round that earnings growth will not be allowed to threaten the inflation target," he said.

But Simon Briscoe at Nikko Europe disagreed. "It would be wise for the MPC to refrain from tightening policy until there are stronger and more convincing signs of rising price pressures," he said.

Hopes that the Bank of England will choose this course were boosted by the expectation yesterday that neither America's Federal Reserve Board nor Germany's Bundesbank would increase their interest rates.

The Fed lived up to this hope by announcing no change after the financial markets had closed in London yesterday, and part-way through the MPC's two-day deliberation. The Bundesbank Council meets this morning.

Central bankers in the leading advanced economies are sensitive to the potential impact of the Asian crisis, and the Fed in particular is expected not to increase US interest rates until the economic spillovers are clearer and the financial markets in the Far East have stabilised.

Officials from European and Asian countries meeting in London to prepare for the summit of EU and APEC ministers in early April are likely to issue a statement on their assessment of the crisis today. Asia will also be the main item on the agenda when finance ministers and central bank governors from the G7 countries meet in London later this month.