Economic recovery on track, but protracted

THE CBI is forecasting slightly faster growth in 2010 after a strong pick-up in manufacturing activity.

In our latest economic forecast, we predict that the UK economy will grow by 1.3% in 2010, up from 1% in our previous March forecast. The slight upward revision reflects the relative strength of the economy over recent months, with industrial production showing solid growth and overseas demand for UK-made goods strengthening, buoyed by the relative weakness of Sterling. The GDP forecast for 2011 remains unchanged at 2.5%.

Looking at quarter-on-quarter growth: after posting first-quarter growth of 0.3% this year, the CBI expects the economy to grow by 0.8% in the second quarter, followed by slower rates of 0.5% and 0.4% in the latter half of 2010. Quarterly growth is then forecast to pick up slightly from 0.6% to 0.8% over the course of 2011.

However, the outlook remains uncertain, particularly with government spending expected to fall sharply, as much-needed steps to restore the public finances are taken in the forthcoming emergency Budget.

Richard Lambert, CBI director-general, commented: "Over the last three months the political and economic backdrop at home and abroad has shifted dramatically. Turbulence has returned to global financial markets as concerns about European sovereign debts have intensified, underlining the need for the UK to tackle its large budget deficit urgently.

"Although the risks to the economic outlook have increased, our view is that the UK's tentative recovery will be sustained. However, economic growth will be weak and we do not expect a return to pre-recession GDP levels until 2012.

"It is clear that the private sector will have to be the main driver of economic growth to offset lower government spending. It is therefore essential that next week's emergency Budget creates the right conditions for businesses to drive growth and create new jobs, as well as setting out bold action to repair the public finances."

Higher inflation, weak wage growth

Against a backdrop of higher inflation and relatively weak wage growth, household spending is forecast to struggle this year, growing by 0.4%. Stronger growth of 2.2% is expected next year as the labour market improves. Household savings are expected to remain at high levels, before falling back through 2011.

Business investment is expected to stabilise this year, following last year's record contraction. But it will recover sluggishly, as firms are lumbered with spare capacity and take a cautious approach to spending decisions in the face of continuing economic uncertainty.

Ian McCafferty, CBI chief economic adviser, said: "The modest upward revision in our forecast for economic growth this year reflects a temporary strengthening in the pace of economic activity this quarter, with exporters benefiting from the global rebuilding of stocks.

"Growth is likely to be tempered somewhat in the second half of the year, as government spending cuts get underway. However, the recovery is forecast to build some momentum next year when the spending of households and businesses is expected to strengthen.

"We are encouraged by the Coalition's commitment to swift action to reduce the deficit, and the publication of the Office of Budget Responsibility's independent forecasts should provide ministers with more realistic assumptions to work from."

Inflation in recent months has come in higher than previously forecast following the increase in VAT, higher oil prices and increased import costs after sterling's decline. However, it is predicted to fall back sharply over the coming year, dropping below the government's 2% target in the second quarter of 2011.

Interest rates likely to rise slightly

The Bank of England is expected to move away from the current emergency stance and nudge interest rates higher later this year. But monetary policy is expected to remain loose over the forecast period, with interest rates reaching 2% by the end of next year.

UK exports are expected to grow by 5.3% in 2010 and 6.9% in 2011, with net trade expected to make a positive contribution to quarterly GDP growth rates through to the end of 2011.

Unemployment is expected to peak at 2.7m early next year and to fall only slowly thereafter.

Public sector net borrowing is forecast to reach £152bn1 in 2010/11, before falling to £128bn in 2011/12, representing 10.4% and 8.4% of GDP respectively.