Bank faces 'two-speed' dilemma as retail booms and manufacturing falters

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Spending boom provokes fears of sharp rise in interest rates

The Bank of England was yesterday faced with a return to the two-speed pattern of economic growth that has bedevilled its decision making over the past few years.

Manufacturing investment has plunged to an eight-year low while business optimism has "stuttered", according to new figures that took the shine off a massive surge in high street spending last month.

Industrial firms cut their investment budget for the first three months of the year to the lowest level since the middle of 1994, official figures showed.

The gloom was compounded by a survey from the employers' group CBI, which showed April's surge in optimism has evaporated this month.

The reports contrasted starkly with official retail sales figures, which showed the high street enjoyed its strongest boom for more than four years in April.

The contrasts may serve to widen the split on the Monetary Policy Committee, which emerged in the latest minutes of their discussions, between those who believe a rate rise will be needed imminently and those who think such a move is still some way off.

The financial markets reacted swiftly to official figures showing a 1.7 per cent surge in retail sales in April, compared with analysts' forecasts of just 0.6 per cent.

This was the best month since a one-off Millennium surge in January 2000 and, before that, October 1997.

The surge was driven by a leap in non-food sales, which rose at an annual rate of 9.5 per cent, the strongest rate since May 1988.

Sales of clothes and sales via mail order and the internet both enjoyed their best month since records began 18 years ago, with annual growth of 17.1 per cent and 15.4 per cent respectively.

City economists said that further evidence of strong consumer demand would add to arguments on the MPC for rates to be raised sooner rather than later.

"If evidence was ever needed that rates should rise, this is it," John Butler, UK economist at HSBC, said.

Others pointed out that growth in the amount of money spent had fallen back while the price charged by shops fell at their fastest rate for 18 months.

"That won't stop the hawks from calling for rate hikes on the back of these numbers, even though the reality is that prices are falling on the high street," Geoffrey Dicks, at Royal Bank of Scotland, said.

The bullish outlook was further undermined by a series of figures showing that the nascent industrial recovery may already have stalled.

The CBI said its monthly poll of manufacturing executives found that a large jump in optimism seen in its April survey had vanished.

It said 28 per cent of firms expected output to rise against 24 per cent who forecast a fall, leaving a balance of 4 per cent compared with 14 per cent the previous month.

Ian McCafferty, the CBI's chief economic adviser, said: "We have seen a stutter across the world. Recovery will be a long and drawn out process and is certainly not assured."

Meanwhile investment by British firms in the first quarter of 2002 fell 1.1 per cent from the fourth quarter of 2001 to stand 3.4 per cent lower than a year ago.

This was driven by a 12.3 per cent annual drop in manufacturing investment to its lowest level since 1994. Private construction and other production investment fell 6.5 per cent.

The data will feed into revised figures for first-quarter GDP published later today. Economists believe an upward revision is unlikely in the wake of weak manufacturing, trade and investment numbers.

Meanwhile an indicator of future UK economic activity slipped for a third month in March to its lowest level for seven months, suggesting the pace of economic growth may ease in 2003 after peaking late this year.

Simon Rubinsohn, chief economist at City brokerage Gerrard, said: "There are so many uncertainties and so much of the growth is down to the consumer.

"People want to see the business sector kick in and that hasn't happened yet, so why take the risk of damaging with a rate hike the consumer economy when inflation is still so subdued."

The CBI also published its latest economic outlook, cutting its forecasts for GDP growth for this year to 1.7 from 1.8 per cent and maintained its 2003 forecast at 2.7 per cent.

It said the economy would underperform the Treasury's forecasts over both years. "There's a risk the Chancellor is being optimistic about the UK recovery," Mr McCafferty said.

It raised its forecast for interest rates, saying they would hit 5.25 per cent by the end of 2003.