America's manufacturing industry boomed in December, according to the first economic figures of 1997. The National Association of Purchasing Managers' index of activity jumped compared with the previous month.
More worryingly, the prices index, one of the figures closely scrutinised by the Federal Reserve chairman, Alan Greenspan, increased.
"There is a sense that inflation is building in the pipeline," said Christopher Low, an analyst at HSBC Markets in New York. "The financial markets will begin speculating about a policy tightening, and interest rates will have to rise in deference," he added.
The activity index rose to 54 from 52.7 in November. Its prices component surged from 45.9 to 51.5, above the watershed between falling and rising prices and the highest level since mid-1995.
Even before the New York market opened, London had already struggled to maintain the poise of the holiday season, with dealers casting one eye back to Wall Street's 100-point fall on New Year's Eve and one forward to the expected US economic data. After clawing back an early 40-point fall, the purchasing managers' index knocked it afresh and the market had closed before the US market itself regained its composure. The Dow Jones Industrial Average ended a volatile day down 5.78 points at 6,442.
"UK shares are more sensitive to US rates than to UK rates," said Robert Buckland, equity strategist at HSBC James Capel. "I think we'll have a bumpy ride in the first quarter, but more because of US rates than because of any political noise the UK elections will provide."
Most traders remained sanguine about prospects for the London market, however. Martin Lupton, head of trading at Kleinwort Benson said: "This might slow investment in UK shares through next week, but the fundamentals remain good here and this market will gather steam. There's a lot of value in this market."
Hardest hit by the sell-off were companies that depend on the US economy for a large proportion of their sales such as Glaxo Wellcome, SmithKline Beecham and BTR. The persistent strength of the pound compounded exporters' problems and BP and Shell, big dollar earners, led the FTSE 100 index lower.
Although few Wall Street analysts expect the Fed to raise its key interest rate as early as the next policy meeting at the beginning of February, many think the move will come before too many months pass. The prospect of an increase in interest rates drew closer in the UK too.
The recovery in British manufacturing faltered last month because of the strong pound. But the UK Purchasing Managers' survey suggested that industry will soon resume its strong upward trend.
A separate survey of the construction industry published yesterday pointed to better prospects this year than any time since the late 1980s.
Manufacturing activity expanded in December but at the slowest pace since August, the monthly survey of purchasing managers reported. A reduction in stocks to meet year-end inventory targets reduced output growth.
City economists thought the news would allow Kenneth Clarke to stave off the next rise in the cost of borrowing until February. "Interest rates should be left on hold until the extent of the recovery is clearer," said Simon Briscoe at investment bank Nikko.
However, the survey did not point to alarming weakness in industry. "If I were the Chancellor, I'd use this in evidence. But the slowdown is no more than you would expect in a three-week month, and I would be very surprised if the upward trend did not resume," said Peter Thomson, director general of the Chartered Institute of Purchasing and Supply which compiles the report.
The headline index fell to 52.5, down from 54.2 but safely above the "boom and bust" dividing line of 50. Growth in new orders declined slightly but remained robust. Although the stronger pound had some impact on manufacturers of consumer goods, overseas demand for capital goods remained strong.
The real slowdown came in output and stocks. Stocks of both purchases and finished goods declined sharply. The CIPS said this reflected deliberate destocking to meet end-of-year targets.
On the other hand, employment rose for the fifth month running and the prices manufacturers paid for imported materials declined.