Fears of back-to-back rate rises

Fears of the first back-to-back increase in interest rates for nearly three years rose dramatically yesterday after news of a jump in pay deals in the crucial January bargaining round.

The average settlement in the three months to January was 3.5 per cent, up sharply from 3.05 per cent in the previous three months, according to data leaked from Incomes Data Services. Although they briefly touched this level in 2001, pay deals have not been at or above 3.5 per cent for a sustained period since 1998. The average was based on 64 January settlements compared with a final total of 225 last year.

Ken Mulkearn, the editor of IDS Pay Report, predicted a further increase. "Many of the January awards included in our latest snapshot were reached before inflation rose sharply to 4.4 per cent, and it would be reasonable to expect that this figure will be a key influence on settlements concluded after it was announced," he said. British Airways awarded its staff an inflation-busting 4.6 per cent pay rise this week.

The figures will be uncomfortable reading for the Bank of England's Monetary Policy Committee, which is concerned that the rising cost of living may spark a wage-price spiral. Alan Castle, an economist at Lehman Brothers, said they increased the probability of a rate rise at next week's MPC meeting from 20 to 33 per cent.

"The combination of hard evidence of higher pay settlements (and the risk of more bad news to come), the likely pick-up in household inflation expectations implied by Wednesday's consumer confidence data, and the continued signs of firms being more willing to raise prices and widen their profit margins, makes us more concerned that the Bank could surprise markets again," he said. The MPC stunned the City with a quarter-point rate rise to 5.25 per cent last month, but only five of 62 economists polled by Reuters expect another increase next week. Back-to-back rises have not been seen since May/June 2004.

The IDS was forced to release the figures earlier than planned after they were leaked to Lehman Brothers, which put out a client note. Mr Castle said: "I had been having problems getting hold of IDS reports, so had befriended a lowly production assistant who sent me a very early draft of the January report. I was under the impression that it was publicly available until things spiralled out of control. I think IDS is a bit pissed off, but we've smoothed things over." IDS said it would be conducting an investigation into the leak.

Adding to the rate jitters were fresh signs of inflationary pressure in manufacturing. The CIPS/RBS Purchasing Managers' Index, a closely watched barometer of the sector, showed factory activity accelerated in January for the first time in four months thanks to a pick-up in production and new orders.

But the gloss was taken off the good news by a surge in raw material costs, which companies passed on at the factory gate in the form of higher prices.