Record factory costs heighten UK inflation woes

British manufacturing activity grew at a record pace in January and price pressures also picked up, re-igniting speculation the Bank of England may have to raise interest rates sooner rather than later to tame inflation. Earlier on Tuesday, a leading think tank said British monetary policy was too loose, and urged the government to ease back on fiscal tightening to give the BoE greater scope to control inflation without damaging the economy.
But weak housing market and credit data may mean the central bank is reluctant to increase borrowing costs just yet. The Markit/CIPS purchasing managers' index showed factory activity, employment and new orders all grew at their fastest clip since the survey began almost 20 years ago - a rare bright spot in an economy facing a major government austerity drive and sluggish consumer demand.
The manufacturing data also suggested pipeline inflation pressures were continuing to build, however, as the cost of raw materials also accelerated at a record rate, and firms were able to raise prices at their fastest in more than two years. That is likely to concern BoE policymakers, who are facing growing pressure to tackle inflation, currently running at almost double he central bank's 2 percent target, while at the same time support a fragile economic recovery.
The pound climbed three-quarters of a cent against the dollar and interest rate futures plunged after the data, which fuelled expectations the BoE may be tempted to start raising interest rates soon, despite a shock fall in GDP in late 2010. The BoE has held rates at their record low 0.5 percent for almost two years, but policymakers are becoming increasingly uneasy about persistently rising prices.
Two of the nine-member policy committee voted to raise rates last month, while for others the decision was "finely balanced", and they preferred to wait until they have updated inflation and growth forecasts later this month before taking the leap.
Although the manufacturing sector has been in robust health for some time - partly due to a 25 percent depreciation in the pound in the last two years - it accounts for just 13 percent of economic output. The services sector, by contrast, accounts for three-quarters of gross domestic product and is still very weak. It is likely to remain under pressure as the government's spending cuts and tax hikes bite. Other data on Tuesday showed the housing market remained in the doldrums, and the flow of credit to the wider economy was still constrained, adding to the gloomy outlook for consumption.