Growth rebound spurs fears of higher interest rates

The UK economy rebounded from its post-millennium hangover to post stronger than expected growth in the second quarter. The economy has now enjoyed exactly eight years of uninterrupted growth.

The UK economy rebounded from its post-millennium hangover to post stronger than expected growth in the second quarter. The economy has now enjoyed exactly eight years of uninterrupted growth.

The first estimate of GDP, published yesterday, showed the economy grew 0.9 per cent between the first and second quarters, giving annual growth of 3.1 per cent. This was higher than the 0.8 and 3.0 per cent expected by the markets and fuelled speculation that interest rates may rise again as soon as next month. Both sterling and bond yields rose on the news. The growth is a strong rebound from the 0.5 per cent quarterly growth over the three months to March. A spokesman for the Office for National Statistics, which compiled the data, said: "There was a pause. What happened in the first quarter was not there in quarter two."

The ONS said there was growth in all sectors of the economy except construction. Services grew by 3.6 per cent year-on-year, its strongest performance for almost two years. The strongest sector was business services although no figures were available. The ONS estimated the industrial sector grew following its fall in the first quarter. Manufacturing also rebounded on the back of a recovery in the electronic, machinery and semi-conductor industries. The unseasonably cold weather during April, May and June boosted the gas extraction and energy supply industries, it said.

The figures appeared to add little to the interest rates debate. Some said the boost in services would be food for the hawks on the Monetary Policy Committee (MPC). "GDP growth is running above trend," said Michael Saunders, of Salomon Smith Barney. "At some point soon, base rates are likely to have to rise to ensure that growth does slow to trend quickly."

The figures come on the back of claims by leading economists that the increase in public spending announced by the Chancellor in the Comprehensive Spending Review last week will force rates higher unless there is marked slowdown in the domestic economy.

The most recent minutes of the MPC's meetings show that as many as three of the nine members believe it will cause the economy to overheat. On Thursday, the National Institute for Economic and Social Research, and Goldman Sachs, said they backed that view.

But other analysts said the GDP data contained support for the view that rates had peaked. Jonathan Loynes, of HSBC, said that without the weather-related boost to the production industries, underlying growth was weaker than the data showed. "We stick to the view that rates have peaked at 6 per cent," he said, while conceding that the strong figure would add "some nervousness".

The financial markets took a hawkish view. The pound added a cent against the dollar while the yield for December sterling futures implied rates would reach 6.5 per cent by the end of the year. The GDP figures tend to be subjected to revisions before the final figures are published, due on 27 September. This might encourage the MPC to stay on hold until it gets a clearer picture, some believe.