Rate rise looks less likely as growth in services slackens

New figures have boosted City hopes that the Monetary Policy Committee will not raise interest rates today. But, as Lea Paterson explains, mixed economic signals make the outcome hard to predict.

After a day and a half of deliberation, the Bank of England's Monetary Policy Committee (MPC) will announce at midday today whether interest rates will rise for the sixth time since the general election. Figures out yesterday strengthen the case for leaving rates where they are. Demand is still booming for services, according to a survey by the Chartered Institute of Purchasing & Supply (CIPS), but the sector is growing at its slowest rate this year.

Dharshini David, economist at HSBC Markets, said: "The figures were slightly weaker than we expected. The signs are that recent monetary policy tightening is taking the steam out of the services sector."

Geoffrey Dicks, economist at NatWest Markets, is among those who believe the recent interest rate hikes have done their job. He said: "The Bank should not raise rates tomorrow. In fact, in six months time we'll be asking how fast rates can come down."

According to CIPS, the business activity index for the services sector fell from 59.1 in October to 57.5 in November. As the index is above 50, that means the sector is still booming. But the fall in the index indicates the pace of growth has decelerated.

Yesterday's figures seem to contradict data released earlier this week. On Monday, it was announced that consumer credit was up by pounds 0.9bn in October, that growth in the UK's manufacturing sector had hit a seven- month high and that, according to the Halifax, house prices grew by 0.9 per cent last month.

These mixed signals have prompted many economists to believe that the Bank should wait until the economic picture clears before moving interest rates again.

"The chances are that the MPC will hold out for a few more months," said Ms David yesterday. She added that, if the Bank were to wait until early next year, the next inflation report, due out in February, could provide it with a justification for raising rates again.

Particularly encouraging in yesterday's CIPS survey of services was that inflation seemed to be under control. Ms David said: "The most striking news was on the inflation front, where the average prices balance of 50.0 signified no price rises for the first time since October 1996." Mr Dicks agreed: "The prices number was encouraging."

It was not all good news yesterday, though. A buoyant input cost index - at 56.9 - suggested that skill shortages are putting upward pressure on wages.

This is not the first sign that capacity constraints in the economy could be beginning to bite. On Monday, the CIPS's manufacturing survey found that delivery times, seen by many economists as an indicator of future inflation, were lengthening. "Rising pay costs will ultimately push up input prices and induce a further rise in interest rates," commented ABN Amro.

Economists believe that the competitive pressures are acting as the main constraint on prices at present. Peter Thomson, director general of CIPS, said: "Competition is becoming increasingly fierce. For the first time since November 1996 firms have been unable to raise their prices charged, at a time when their costs continue to rise." NatWest Markets noted: "The one concern is that these competitive pressures may weaken, with firms struggling to meet the existing business flow."

The strong pound is also helping keep a lid on inflation by reducing the cost of imports, according to some economists. CIBC Wood Grundy noted: "The strong currency keeps any potential upwards price pressure down through smoother input prices."

According to Mr Dicks, the pound is another reason a rate rise is unlikely today. He said a rate rise would push sterling through the DM3 barrier, a result which would be unpalatable to the MPC.

The committee's two-day meeting, which started yesterday, will be the first full meeting of the committee. Sir Alan Budd, previously in attendance just as an adviser, is now a voting member after relinquishing his previous responsibilities at the Treasury.