By Max Clarke

The impact of December’s bad weather means the UK’s leading business group now expects this year’s GDP growth rate to be 1.8%, down slightly from an already sluggish 2.0%. Its forecast for 2012 is for slightly faster growth of 2.3%, down from a forecast of 2.4% in December.

Although a number of risks to the outlook remain, the UK economy is still on the road to recovery, and the CBI maintains its view that the risk of a double-dip into recession is low.

John Cridland, CBI Director-General, said:

“The early estimate for GDP growth in the final quarter of last year came as a surprise to everyone, suggesting that underlying growth may have been weaker than previously thought.

"We must wait and see just how weak it was, and how much was down to December’s bad weather, but we do expect growth in 2011, albeit rather anaemic and sluggish, which will accelerate during 2012.

“With household spending under some considerable strain, we will be looking to business investment and exports to help deliver economic growth over the coming two years. While this growth will still be lower than the long-term average and unemployment will continue to creep up, job numbers will also increase as the recovery picks up.”

Despite the New Year rise in VAT, a bounce back after the bad weather of December is expected to help quarter-on-quarter growth edge up to 0.6% in Q1 2011. The CBI’s forecast for the remainder of 2011 is broadly unchanged, with steady but modest growth of 0.5% expected over each of the next three quarters.

Quarterly growth rates are still expected to accelerate gradually during 2012, with the economy forecast to expand by 2.3% over the year as a whole. This is still rather subdued for this point in a recovery.

Inflation will remain stubbornly high during this year, partly due to the impact of higher VAT but also due to pressure from rising energy and commodity prices. CPI inflation will exceed the Bank of England’s 2% target in 2011 for a second year running.

The CBI predicts that the Bank will start to normalise monetary policy in the spring, with interest rates edging up gradually, reaching 2.75% by Q4 2012. With this gradual rise in interest rates and the VAT increase falling out of the equation from January 2012, inflation is forecast to settle close to target throughout 2012.

Ian McCafferty, CBI Chief Economic Adviser, said:

“The economic outlook remains subdued, and conditions for the consumer will be tough for some time to come. But the economy will grow in the coming two years and, despite the recent shock of the estimate for GDP in Q4 2010, we do not foresee a double-dip recession.

“What remains the case is that growth at this stage is far less robust than we would normally expect for the second and third year of an economic recovery.

“Persistently high levels of inflation, caused by rising energy and commodity prices and the VAT increase, are also a concern. This makes it more likely that the Bank of England will need to start putting up interest rates from their record low level from the second quarter of this year.”

Unemployment is forecast to continue rising during 2011, peaking higher than previously forecast at 2.71 million by the end of the year. It will remain stubbornly high during 2012, and be at 2.64 million by Q4 2012.

Pay growth is expected to strengthen a little over the coming two years. However, the outlook for consumption is expected to remain subdued. Household spending is forecast to rise by only 0.7% in 2011 and 1.3% in 2012, reflecting the further erosion to consumer spending from higher inflation and VAT, weak wage increases, higher mortgage interest rates and ongoing concern over unemployment.

The lacklustre growth in domestic demand means, however, that export growth should outpace the rise in imports during the forecast period, and net trade is expected to make a positive impact to GDP for the coming two years, as the economy rebalances somewhat over the forecast period.

UK exports are expected to grow by 6.6% this year and 7.8% in 2012. Exporters should continue to benefit from a competitive level of sterling and healthier levels of growth in major international markets.

Business investment is also expected to help drive economic growth. The recession saw business investment nosedive, but it began to turn a corner during last year. Growth of 9.2% is forecast in 2011 and 8.1% in 2012.

A decline in public sector net borrowing (excluding financial interventions) is forecast over the next couple of years, from £149.7bn in 2010/11 to £99.4bn in 2012/13.