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CEBR special report: Danger of early rate hikes

The economic news over Christmas and New Year has pointed to strong activity in the UK and continental Europe, and this may well push their respective central bankers into putting up interest rates soon.

The picture from the US has been patchier, although firm consumer spending figures and today’s data showing a 167,000 jump in non-farm payrolls in December suggest that GDP growth was better in the fourth quarter of 2006 than in the third, when it was an annualised 2%. A cut in American interest rates looks a long way off.

We have been predicting a bumper last few weeks of 2006 for the German economy, ahead of last week’s 3% rise in VAT, and the figures seem to be backing up our predictions handsomely.

The Ifo index for December jumped to a new multi-year high of 108.7 from 106.8, while the purchasing managers’ index for manufacturers rose to 59.4 from 58.3 and the equivalent index for service sector firms jumped to 57.6 from 56.8.

Although French numbers have been much more mixed, the German news combined with an acceleration in euro area M3 growth to 9.3% in November, from 8.5%, is likely to put pressure on the European Central Bank to raise interest rates in February.

This Thursday’s ECB meeting is likely to see its president, Jean-Claude Trichet steering the market to expect a rate rise next month.

A rate rise is also likely in the UK in February – assuming that the Monetary Policy Committee does not catch the markets on the hop by ordering one at its January meeting this Thursday.

Decent Christmas retail sales, strong house price figures and the recent jump in CPI inflation to 2.7% suggest rates will reach 5.25% in the next few weeks.

However it may not be too long in 2007 before the markets start to perceive that an international economic slowdown is underway.

One sign is the sharp fall in copper prices, from a $8500-a-tonne peak last summer to just $5600 in recent days.

Another is the fall in oil prices to the mid-$50s-a-barrel. Another is likely to be a standstill in German sales in January, as the VAT increase bites.

A fourth may be softer UK High Street sales in early 2007, in response to the squeeze on real wages from Retail Prices Index inflation at 3.9%.

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