Britain’s booming recovery could force BoE’s hand on rate hike

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The chances that the Bank of England will raise interest rates later this year climbed after activity in Britain's services industry, the economy's dominant sector, climbed at its fastest pace since November.

The Markit/CIPS services purchasing managers' index (PMI) hit 59.1 in July, well ahead of economists' forecasts, from June's reading of 57.7. Any reading greater than 50 indicates expansion.

"The domestic economy clearly continued to boom in July," said Chris Williamson, Markit's chief economist in London, adding that the March to June growth rate of 0.8 per cent is expected to be repeated in the July to September months, taking the annual growth rate to a healthy 3 per cent.

Economists think the continued strength in the British economy, in marked contrast to most other European Union economies, will put pressure on the Bank of England to raise interest rates sooner rather than later. While some economists think a rate hike could come late this year, others think the apparent lack of inflationary pressures are more likely to delay any increase until some time in 2015.

In a note, ING economist James Knightley said the new services PMI "suggests that the UK economy is maintaining its momentum in the third quarter and will increase speculation that one, possible two members of the Bank of England's MPC [monetary policy committee] will be vote for a rate rise at Thursday's policy meeting."

Mark Carney, the Bank of England governor, will update the bank's economic forecasts on Aug. 13. It is likely he'll comment on how much spare capacity remains in the economy before inflation pressures kick in.

The National Institute of Economic and Social Research (NIESR) predicted the first rate hike will come early next year. Some watchers of the economy and the Bank of England fear that the central bank's MPC will move too slowly in raising rates and that the MPC will have to make up for lost time with a potentially damaging rapid-fire sequence of rate hikes.

The MPC was surprised by the strength of the British recovery last year, when it rolled out its "forward guidance" policy – the assurance, more or less, that interest rates would remain at 0.5 per cent until the jobless rate dips below 7 per cent. The rate fell far faster than expected and was measured at 6.5 per cent in the three months to May, down from 7.8 per cent a year earlier. The NIESR now expects unemployment to fall to 5.8 per cent by the end of 2014, taking it to the lowest level since mid-2008, just before the start of the global financial crisis.

Britain's recovery is the envy of the euro zone, whose gross domestic product is expected to rise by only 1 per cent this year and 1.8 per cent in 2014. The European Central Bank is under no pressure to raise rates because unemployment remains at double-digit levels and inflation has fallen to 0.4 per cent, well below the target rate of close to 2 per cent. Outright deflation – falling prices – remains a threat.

In June, the ECB introduced a negative interest rate – charging banks to keep overnight money at the central bank. The goal was to encourage banks to lend out the money instead of hoarding it.