Britain: Time to Head Off Inflation

The British economy is starting to fire on all cylinders as the manufacturing sector slowly recovers. But uncertainty in the financial markets and tame inflation will make any decision by the Bank of England to hike interest rates especially tricky.

The first look at second-quarter real gross domestic product showed the economy grew by 0.9% (chart) after posting two straight quarterly gains of just 0.1%. It is the biggest quarterly rise since the last quarter of 1999.

The government reported that service-sector output, the primary engine of growth for more than a year, rose by 0.6% from the first quarter but continued to slow on a yearly basis. The World Cup and the Queen's Golden Jubilee hurt retail sales in June, but an ebullient housing market should keep consumer spending healthy.

More important, though, industrial output was estimated to have grown strongly, with the manufacturing sector breaking its string of five consecutive quarters of declining output. Through May, industrial production is up 1.8% from the first quarter. Tech equipment is showing its first rise since the end of 2000, and production of durable goods is up 4.3% as well.

However, the FTSE 100-stock index is among several key indexes around the globe that is down more than 20% this year. The plunge pushed consumer confidence to a seven-month low in July, even though consumers' outlook of their own finances improved. Also, the Confederation of British Industry's survey of industrial confidence showed surprising weakness in the third quarter.

Amid rough financial waters and inflation below its 2.5% target, the BOE is under little pressure to raise interest rates. But the economy is expected to grow better than 3% next year, vs. forecasts just shy of 2% for 2002. Such a healthy pace has the BOE projecting a pickup in inflation next year. With all sectors of the economy now growing and with a big boost in government spending on the way, the BOE is almost certain to raise rates before yearend.

By James Mehring in New York

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