Strong high-street sales rekindle fears of increased interest rates

Higher interest rates are back on the agenda after stronger than expected retail sales, falling unemployment and a rise in average earnings growth scotched recent hopes that the buoyant economy was moderating. Tom Stevenson, Financial Editor, sifts the data.

Retail sales continued to rise in August, fuelling fears that the Bank of England's pause for breath after a series of four interest rate rises might be short-lived. Analysts said the strength of high street sales was surprising given the poor weather and large numbers of people who had left the country on windfall-financed holidays.

The 5.6 per cent year-on-year rise in retail sales chimed with the lowest unemployment rate since August 1980 and average earnings rising at an annual rate of 4.5 per cent to paint a picture of a continuing boom.

Meanwhile, minutes from the August meeting of the Bank of England's Monetary Policy Committee confirmed the increasing concern of policymakers that rates will need to rise if the economy is to meet the Government's inflation target.

Adam Cole, UK economist at HSBC James Capel, said the strength of the high street data supported his view that the market had been premature in looking for a slowdown in demand. "The strength of consumer spending reflects more than just the impact of the windfall gains - one only has to look as far as today's labour market data for evidence of this."

That background, he added, meant the upside risks for base rates were greater than markets had priced into valuations. That had been underlined by the minutes of the 7 August meeting of the Monetary Policy Committee which showed its members voting unanimously for higher base rates.

Another surprise in the minutes was the revelation that the Bank had actively considered intervention to reverse the strength of the pound which caused exporters such problems early in the summer. Its unusual comments to talk down the pound were seen as an unexpected change of tack by the traditionally discreet "Old Lady".

One of the big disappointments for inflation hawks in yesterday's data was that official sales figures flatly contradicted evidence from the Confederation of British Industry and British Retail Consortium suggesting spending slowed in August.

Nick Stamenkovic, economist at DKB International, said the data reinforced the Bank's concerns that the economy was growing too strongly. And for Michael Dicks, UK economist at Lehman Brothers, the Bank of England's decision to sit back and take stock of the economy was putting it behind the curve. "Over the summer, the rate rises were pre-emptive but now we're back to the more traditional pattern in the UK of too little too late."

With September data largely meaningless thanks to the loss of an important trading day as the country watched Princess Diana's funeral, the Bank of England is expected to persist with its cautious stance for a couple of months, but economists agreed that a rate rise by the end of the year was likely.

David Dharshini, at HSBC Markets, said: "These stronger-than-expected figures confirm that the windfalls continue to find their way to the high street. With sales growing by over 2 per cent in the latest three months, these numbers are unlikely to escape the notice of the MPC, and suggest that base rates have yet to reach their peak."

Unemployment fell 48,600 in August after a decline of 54,600 (revised from 49,800) in July. That took the jobless rate back to 5.3 per cent, its lowest since 1980. Vacancies were 6,900 higher in August and 23 per cent up on the previous year. That tightening labour market was reflected in underlying average earnings, which were 4.5 per cent higher in July than a year earlier. The increase in June was 4.25 per cent.

According to Francesca Massone of Goldman Sachs: "On any measure, the labour market is still tightening at an alarming rate. Vacancies are 57 per cent above their long-term trend and unemployment is now 97,000 below its previous cyclical low."

She pointed out that the rise in average earnings growth was due to a recent settlement in the construction sector, which is suffering more than most sectors from labour shortages, but warned that those could easily spill over into other industries. She predicted a further half-point base rate rise by next spring.