Britain's factory activity grew at its fastest pace in 16 years at the end of 2010 and mortgage approvals rose, data showed on Tuesday, but tax rises and public spending cuts will provide stiff headwinds in 2011. The Markit/CIPS manufacturing Purchasing Managers' Index rose to 58.3 in December from November's 57.0, well above expectations and its best reading since September 1994.
-- UK manufacturing PMI at 16-year high in Dec
-- Mortgage approvals rise unexpectedly in Nov
-- Rise in VAT, public spending cuts to drag on 2011 growth
Separate figures from the Bank of England showed mortgage approvals rose in November to their highest since July, easing fears of further steep declines in house prices. The figures will be welcomed by the government which is hoping the private sector will be able to expand to fill some of the space left by its pruning of the state sector - the biggest budget cutbacks in a generation.
However, some of the detail was less encouraging. Consumer lending and money supply growth both weakened in November, and the robust expansion in the manufacturing sector was coupled with an unprecedented rise in firms' costs - the latter a particular worry when inflation is already well above target.
"It is vitally important that the UK economy is on as firm a footing as possible as the fiscal tightening really starts to bite from early-2011, beginning with the VAT hike," said Howard Archer at IHS Global Insight. "The only real blot on the (purchasing) survey was the record rise in input prices."
The Conservative-led coalition government, which took office last May, plans to cut the budgets of most government departments by just under a fifth over the next four years. It is hoping its tough fiscal stance will be offset by loose monetary policy. But the recent strength of inflation has fanned debate about how long the BoE can keep interest rates at a record 0.5 percent without losing credibility.
Inflation rose to a six-month high of 3.3 percent in November and may rise above 4 percent in the first few months of this year, double the BoE's 2 target. Adding to upward price pressure will be the rise in VAT sales tax - from 17.5 percent to 20 percent - which came into force on Tuesday. Finance minister George Osborne said increasing VAT posed less of a risk to the broader economy than increasing income tax or other payroll taxes. However, calculations from the government's own fiscal watchdog show the measure alone will shave 0.3 percent off economic output in 2011/2012. "Clearly there will have been some shuffling of consumer spending into December last year and away from the early months of 2011 as consumers tried to beat the hike," said David Tinsley, UK economist at National Australia Bank.
PRESSURE FOR UK RATE RISE Even if growth slows sharply, the BoE's ability to respond with further stimulus is limited. A Citi/Yougov survey on Tuesday showed British public inflation expectations rose to 3.5 percent in December, its highest level in more than two years. Money markets, which as recently as November were pricing in a 50:50 chance of more quantitative easing, have swung to pricing in a UK rate rise in the second half of 2011.
Tuesday's manufacturing survey will be followed by construction data on Wednesday and a service sector data on Thursday, both of which will shape expectations for UK fourth-quarter GDP data, due January 25. A recent Reuters poll shows economists expect fourth-quarter growth to come in at 0.5 percent, a respectable outturn but weaker than the 0.6 percent registered in the third quarter and the 1.2 percent registered in the second.
Overall, they expected the recovery to slip down a gear at the start of 2011, with growth forecast at just 0.3 percent for each of the first two quarters. "Broad money growth is still heading in the wrong direction. Bank lending remains weak too, and we continue to expect relatively tight credit conditions to act as a brake," said Vicky Redwood at Capital Economics.
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