Dilemma over interest rates

FRESH evidence of Britain's two-speed economy today highlighted the dilemma of the Bank of England's monetary policy committee as it prepares to set interest rates this week.

With the City split virtually down the middle on whether the MPC will lift the cost of borrowing to 4.25% on Thursday after its two-day meeting, new reports showed the service sector powering ahead while manufacturing suffered another disastrous slump.

The latest snapshot of the financial services sector from the CBI showed optimism at its highest for five years during the first quarter.

A net 44% of firms said they were more upbeat about prospects than three months ago, up sharply from December's 29% and the highest balance since June 1999.

Business volumes rose across all financial services, with general insurers, fund managers and building societies reporting the strongest growth. Predicted job cuts failed to materialise, and firms expect to continue recruiting in coming months.

Doug Godden, head of economic analysis at the CBI, said: 'A year of solid business growth, the revival in the stock market last year and growth in the wider economy have given financial services firms a substantial boost.' Meanwhile, a separate survey of the overall service sector indicated continued robust growth in March, albeit at a slightly slower pace than February. The closely-watched CIPS/Reuters purchasing managers' index registered-58.7 against 59.5 the previous month, where a reading above 50 indicates expansion.

'Panellists widely commented that a strengthened economic climate had given them greater confidence when developing and introducing new products, while also leading to a further surge in levels of incoming new business,' the report said.

In stark contrast, the manufacturing sector put in another miserable performance in February, official figures showed. Factory output collapsed by 0.6% against expectations of a 0.4% increase. That left output just 0.2% higher than a year earlier.

A sharp fall in pulp, paper and publishing output accounted for a third of the overall decline, blamed on the fragile publishing sector.

The grim news, which casts doubt on manufacturing's much-vaunted recovery, contrasts with bullish survey evidence from groups such as the CBI which recently declared the seven-year industrial slump now over. Today, National Statistics said it was confident that its measure was the most accurate guide to what was going on.

Economists were divided on whether the manufacturing gloom would stay the MPC's hand on Thursday. David Page at Investec said: 'While most of the economy is recovering, manufacturing remains in the doldrums. We think a move in May is more likely than April.'

But Jonathan Loynes at Capital Economics said: 'Although today's news makes it even closer, rates will still go up on Thursday.'