By David Milliken
LONDON (Reuters) - Britain's services sector expanded at its fastest rate since May 1997 last month, raising the prospect of another big jump in economic growth in the final three months of 2013.
A closely-watched industry survey released on Tuesday easily beat forecasts, while the European Commission and a leading think tank revised up their forecasts for UK growth. That makes it more likely the Bank of England will do the same next week, bringing higher interest rates closer into view.
Living standards - a big political battleground - have yet to benefit, however. Retail sales data were lackluster and company results showed shoppers favoring cheaper stores.
Financial data company Markit said its services purchasing managers' index (PMI) jumped to 62.5 in October from September's 60.3, confounding economists' forecasts for a fall to 59.8.
Markit said that, combined with strong manufacturing and construction PMI surveys, the reading suggests quarterly economic growth of 1.3 percent, up from 0.8 percent between July and September.
"The UK economic recovery moved up a gear again in October," said Chris Williamson, chief economist at Markit.
Sterling rose to a four-week high versus the euro and British government bond prices fell.
"Momentum particularly in the domestically-exposed services sector is stronger than we expected just a few months ago," said Jens Larsen, chief UK economist at Royal Bank of Canada.
"We expect that the (BoE's) forecast will be similarly affected, with a stronger growth profile and a more rapid fall in unemployment compared to their August forecast," he added.
The British central bank pledged in August not to raise interest rates before unemployment falls to 7 percent, something it expected would take more than three years. Many economists think that timescale will be brought forward when it publishes fresh forecasts next week.
Larsen said upward revisions to growth were likely to be smaller than implied by the PMIs, which slightly overstated growth in the third quarter. He predicted a 0.8 percent expansion in the final quarter of 2013.
Britain looked on the verge of its third recession in five years in early 2013, but the economy has since proved surprisingly strong. Markit's composite PMI, spanning the economy, is at its highest since records began in 1996.
That contrasts with weakness in the euro zone, where last week unemployment hit a record high and inflation tumbled, raising chances of a European Central Bank interest rate cut.
On Tuesday, the European Commission sharply raised its forecast for UK growth next year to 2.2 percent but cut its euro zone forecast to 1.1 percent.
Total UK output is still well below its 2008 peak, however.
Markit's survey showed service sector employers hiring staff at the fastest rate since May 1997, while its overall employment index was higher than at any time since its January 1998 debut.
The National Institute of Economic and Social Research think-tank said unemployment would hit 7 percent in early 2016, but that the BoE might raise rates before then if consumer spending and house prices rise strongly.
PUBLIC SECTOR AND CONSUMERS UNDER PRESSURE
Markit's surveys do not cover the UK public sector - where more cuts to jobs and spending are planned as part of the government's austerity program - or British retailers, which have had mixed fortunes due to falling disposable income.
The British Retail Consortium, which represents larger chains, said its members experienced annual sales growth of 2.6 percent in value terms in October, slower than over the summer.
Fortunes vary between retailers. Budget clothing chain Primark <ABF.L> reported a 44 percent rise in profit, while pricier Marks & Spencer <MKS.L> reported a ninth consecutive quarter of falling clothes sales.
Prospects for the rest of the services sector appear brighter. The services PMI's new orders component was at its strongest since the survey started in July 1996.
Some firms cited growing activity in Britain's property market, where the government has announced several measures aimed at boosting construction and home purchases.
There were also signs of future inflation pressure. Firms reported they were reaching capacity constraints, with backlogs of work rising at the fastest rate since May 1997, and that they were raising salaries as well as hiring more staff.
Input costs grew the most in eight months, while prices charged to consumers rose at their fastest since May 2011.
(Editing by Catherine Evans)