Interest rates expected to rise due to building inflationary pressures
By Craig Stirling, Bloomberg columnist
The UK economy, Europe's second biggest, grew faster than expected in the third quarter, stoking speculation that the Bank of England needs to raise interest rates more than once to stop inflation.
Growth accelerated to an annual 2.8%, the quickest pace in two years, according to the Office for National Statistics. GDP rose 0.7% from the previous quarter, driven by service industries and manufacturing. Economists predicted quarterly growth of 0.6%, the median in a Bloomberg News survey.
Rising house prices, record employment and a recovery in manufacturing have pulled the economy back from a slowdown in 2005. Rates on futures contracts rose after the report as investors increased bets the central bank will follow a rate increase to 5% in November with another early next year.
"This will back the bank's view that growth is strong, inflationary pressures are building and interest rates need to rise,'' said Dominic White, an economist at ABN Amro. "We're looking for interest rates to increase to 5.5% next year.''
The implied rate on the December futures contract rose two basis points to 5.27% and the rate on the March contract climbed by the same amount to 5.37%. The contract settles to the three-month London inter-bank offered rate for the pound, which has averaged about 15 basis points more than the benchmark rate for the past decade. The pound gained 0.1% to $1.88 from $1.87 before the report, heading for its first weekly advance against the dollar in a month.
Furthermore, the economy will probably expand 2.7% this year, compared with 3.4% in the US, 2.4% in the euro area and 2.7% in Japan, the International Monetary Fund said.
The UK economy has expanded for 57 consecutive quarters, avoiding the recessions in the US, Germany, France and Italy in that period.
Industrial production, which accounts for about 20% of the economy, expanded 0.3%, after zero growth in the second quarter. Growth of 0.7% in manufacturing, which grew for a third quarter after a slump in 2005, and increased output in energy supply, boosted production. Services such as transport, communication and finance expanded 0.8% in the third quarter, down from 0.9% in the three months through June, the statistics office said. Services account for three quarters of the economy.
"The deceleration in growth comes mainly from retailing, where output slowed after a strong rise in the second quarter,'' said the statistics office.
Retail sales increased 0.8% in the third quarter, the Government said, less than half the previous quarter's pace. Kingfisher, Europe's largest home-improvement retailer, commented that fiscal first-half earnings were unchanged as Britons spent less to refurbish their homes.
Meanwhile, a revival in the $6.7 trillion UK housing market this year, which accounts for 60% of the country's wealth, and record employment have supported consumer spending.
House prices rose 1.3% last month, the most since January, Nationwide Building Society, the UK's third-biggest mortgage lender, said. Employment rose to a record 29 million in the quarter through August.
David Blanchflower, the sole Bank of England policymaker to oppose an interest rate increase in August, explained there was a risk consumer spending may slow amid rising unemployment, which reached a five-year high in September.
His colleagues are more concerned by signs of inflationary pressure in the economy, such as growth in money supply, now at a 16-year high. Governor of the Bank of England Mervyn King and policymakers Timothy Besley and Andrew Sentance have highlighted these risks to inflation, at 2.4% in September, in the past month.
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