Signs of inflation emerge in service sector as rate-setting meeting starts

SIGNS THAT costs and prices in the service sector are on the increase emerged yesterday as the Monetary Policy Committee started its two-day meeting. The MPC is widely expected to announce a quarter-point rise in interest rates at noon today.

Costs - mainly wages - faced by services companies rose at their fastest rate since May 1997, according to the October purchasing managers' survey. Many businesses were unable to absorb the higher costs, resulting in the first increase in prices charged for four months. At the same time, the survey showed the pace of expansion in services slowed compared with the previous month, although it remained healthy.

These latest figures will deepen concerns in both the Bank of England and the Treasury over pay pressures. Recent official figures showed average earnings growth has passed the 4.5 per cent threshold the Bank has said is consistent with meeting the inflation target. Earlier this week the Chancellor, Gordon Brown, repeated his warning that excessive pay rises would threaten economic stability.

According to the purchasing managers' survey, the overall activity index slipped to 55.7 from 57.1 in September. But the cost index jumped from 54.1 to 59.2 while the prices charged index rose to 51.7, indicating prices have started to rise after spending the previous four months bobbing along below the 50 level.

"The survey produced the worst possible mix of weaker activity and orders' growth, combined with a sharp pick-up in costs and prices," said John O'Sullivan, an economist at Greenwich NatWest.

The report noted that the availability of both permanent and temporary staff fell for the fourth month running. Skills shortages were most serious not only for computing staff but also secretarial staff, and appeared to be getting worse.

Competition has so far limited the rise in prices charged by services firms, but many had to pass on increases last month. "The most commonly cited reason was that cost pressures, particularly those relating to wages and salaries, had become too great to leave charges unchanged," the report said.

Although City analysts believe some members of the MPC might stick to their well-publicised views that other pressures, such as the strong pound, are bearing down on inflation, the great majority think the evidence pointing to a rate rise today is overwhelming.

David Owen at Dresdner Kleinwort Benson said: "Many people are too gloomy about the long-run inflation prospects, but an interest-rate rise this week is very likely."

On top of the signs of cost and price increases in business surveys, house prices leapt 2.8 per cent last month according to Halifax. Output growth has also picked up significantly, with manufacturing as well as services expanding comfortably.

This week's MPC meeting is the first since independent members of the committee complained to the Bank's Court of Directors about their lack of research support. The Court is expected to agree to allocate additional resources to economic analysis so the four external members can get more back-up in future.