Industry gloom should hold rates

THE BANK of England's Monetary Policy Committee is expected to vote against an increase in interest rates after its meeting this week, following fresh evidence that manufacturing industry is suffering a recession.

The financial markets have started to look forward to reductions in the cost of borrowing later this year, although some City economists still fear - along with the MPC's minority of hawks - that higher pay growth and an unsatisfactory inflation performance could force one more rate rise.

At its meeting tomorrow and Thursday the MPC will, for the first time, be up to its full strength of nine members. With the Bank of England Act coming into force yesterday, John Vickers, the Bank's new chief economist, takes his place. But even with this new member, those voting for a rate rise this month are expected to be in a minority of two or three.

The latest survey of industry showed a small contraction in manufacturing industry in May, for the second month running. Output was stagnant, while orders and employment declined, according to the monthly survey of purchasing managers by the Chartered Institute of Purchasing and Supply.

The overall activity index edged down from 49.5 to 49.3 last month, both just below the watershed of 50 between expansion and contraction. The output component edged up to 50.4, but the new orders index fell to 49.0. Domestic orders weakened slightly, but dismal export orders were the main culprit.

The employment index fell too, as companies "showed a reluctance to replace labour lost through natural wastage", according to the CIPS.

The detail of the survey showed consumer goods manufacturers still doing well, with the order book growing and output expanding at a reasonably robust rate. However, capital goods manufacturers have continued to suffer from the strength of the pound. Their export orders were down again, and domestic customers have been switching to cheaper imports.

Peter Thomson, the director- general, said: "The question now remains whether the manufacturing economy will slip further into recession or level out."

The CIPS survey follows a gloomy report on manufacturing prospects from the Confederation of British Industry last week. The survey evidence has been more buoyant than official figures for some months, but the latest results have brought them closer into line with the dismal picture of outright recession in industry.

David Mackie, UK economist at JP Morgan, said: "It is hard to be optimistic about where manufacturing can go next." He predicted interest rates would remain unchanged until the end of this year, adding that a reduction later this year, as implied by the sterling futures market, could not be ruled out.

However, some City experts remain concerned about inflationary pressure in the other three quarters of the economy, and especially signs that earnings growth is heading upwards.