By Max Clarke

The CBI continues to forecast 2.0% growth in the UK economy in 2011 and in its new prediction for 2012, slightly faster growth of 2.4% is expected.

Despite many risks to the outlook, and a forecast of particularly fragile growth at the beginning of 2011, the UK recovery is expected to be maintained and the CBI still considers the risk of a double dip back into recession to be low.

The pace of recovery is expected to slow to a very sluggish rate of only 0.2% quarter-on-quarter in Q1 2011, when consumer spending falls slightly in response to higher VAT. Steady but fairly modest growth of 0.4%, 0.5% and 0.5% is predicted over the remaining quarters of 2011.

Quarterly growth rates are expected to pick up a bit more momentum during 2012, with the economy forecast to expand by 2.4% over the year as a whole, which is rather subdued for this stage of a recovery.

The CBI expects inflation throughout 2011 to be higher than previously forecast, reflecting greater inflationary pressure from energy and commodity prices. CPI inflation will significantly exceed the Bank of England’s 2% target in 2011 for a second year, mainly due to the impact of higher VAT. This upward push to inflation will end by Q1 2012, when inflation is forecast to dip just below target before ending the year at 2.4%.

The leading business group therefore predicts that the Bank will start to normalise monetary policy in the spring, with interest rates rising gently through to mid-2012, followed by a slightly faster monetary stimulus withdrawal over the second half of 2012. This will take the Bank Rate up to 2.75% by Q4 2012.

Ian McCafferty, CBI Chief Economic Adviser, said:

“The pace of recovery in the UK economy has been slightly stronger over the past year than we and many others had expected, and somewhat faster than typical during the first year out of a recession. But we do not expect that rapid pace of growth to continue over the next two years of recovery.

“The big early kicker to growth from the turn in the inventory cycle has already passed and we are now starting to feel the impact of lower government spending.

“As a result, quarterly growth at the start of 2011 is likely to be very sluggish, although we do expect the recovery itself to stay on track.

“What is striking is how little we see growth accelerating in 2012. Typically, by the third year of a recovery, growth would be more robust than we expect for either 2011 or 2012.

“Growth prospects for consumer spending look pretty subdued over the next couple of years. Real take-home pay will be hit further next year, unemployment is not expected to fall very quickly in 2012, and households will most likely face higher mortgage interest rates.

“The persistent strength of energy and commodity prices is a growing concern, as it is likely to mean that inflation does not fall back quite as sharply as many hope. This makes it more likely that the Bank of England will need to start pulling back from record low interest rates earlier, rather than later, next year.”

Unemployment is forecast to edge higher over the course of 2011, with a peak close to 2.6 million by the end of the year. Thereafter the recovery in the labour market is expected to be slow during 2012, and unemployment does not dip below 2.5 million until the fourth quarter.

Meanwhile, pay growth is expected to strengthen somewhat over the next two years, following the period of pay freezes and muted pay rises seen in 2009 and 2010.

However, despite slightly higher earnings growth, the outlook for consumption is fairly subdued, as household spending is forecast to rise by only 0.9% in 2011 and 1.2% in 2012. This reflects further erosion to real household disposable incomes next year from high inflation and increased taxation, higher mortgage interest rates, and consumers remaining cautious, given ongoing concerns about employment prospects.

Some rebalancing within the economy is expected over the forecast period. As government spending retrenches and consumer spending rises slowly by historical standards, growth in the UK economy will be driven more by business investment and net trade.

Business investment spending plummeted during the recession, but has started to recover this year. Growth of 7.0% is forecast in 2011 and 8.5% in 2012, although this will still leave the level of business investment spending lower at the end of 2012 than in 2008.

UK exports are predicted to grow next year by 6.9% and 8.0% in 2012, with net trade expected to make a positive contribution to growth over the next two years, as exporters benefit from a competitive level of sterling and sustained growth in most major international markets.

A decline in public sector net borrowing (excluding financial interventions) is forecast over the next couple of years, from £147bn in 2010/11 to £95bn in 2012/13.