Inflation, strong services and manufacturing data point to interest rate increases

Strong data from the services sector, which now makes up 75% of the U.K. economy (and 80% of jobs), a resilient manufacturing base, and inflation way above target makes interest rate increases likely as we move into 2011. Despite negative GDP growth in Q4 2010, the services data from January has given reassurance that the winter weather causes the dip in the economy and that a further period of contraction was unlikely. Consumer confidence remains weak with VAT (Value added Tax) increasing in January adding to the tale of woe for households, partly as a result of tax rises but also huge increases in fuel and food costs during 2010 and 2011. The UN released data last week that a basket of food commodities was not at an all time high, and Brent Crude went as high as $103 a barrel due to the potential impact on the Suez Canal due the Egyptian crisis.

Expectations are that U.K. interest rates will rise 0.25% in April or May, with further increases in the Autumn, with a 1.25% rate by the end of 2011. Good news for savers, bad for borrowers! The Bank of England MPC (Monetary Policy Committee) meets on February 9th and 10th. It is considered unlikely that the Committee will increase rates at this meeting, but given the data flow and the headline rate of inflation at 3.7%, which is double the BOE target, increases won't be far away.