By Max Clarke

The UK economy will continue to grow, at a sluggish rate in 2011 before picking up modestly in 2012, according to the CBI’s latest economic forecast.

Despite the squeeze on household incomes from higher commodity prices and an erosion of business confidence, the CBI still expects the economy to grow by 1.3% this year, compared to 1.7% forecast in May. GDP growth of 2.2% is expected in 2012, unchanged from May’s forecast.

“Economic conditions will be very tough for the rest of this year as household budgets continue to be squeezed by a combination of inflation and weak wage growth, sais CBI Chief Economic Advisor, Ian McCafferty. “But conditions will be a little brighter in 2012 as inflation eases back and take home pay improves.

Positive net trade contributions this year and next are expected to help boost the UK economy, as export growth picks up, reflecting the competitive level of sterling, and imports are more muted because of subdued domestic demand. Exports growth of 7.7% is expected in 2011 and 6.9% in 2012.

Although many firms are well placed to increase investment spending due to the substantial cash surplus in the corporate sector, the UK’s leading business group is warning that investor confidence has been eroded due to Eurozone instability and US debt issues. Only relatively modest investment growth of 3.7% is expected in 2011, but this is likely to pick up in 2012 to match historically strong levels (9.3%).

The economy only expanded slowly in the second quarter, by 0.2%, but this is largely explained by special factors such as the reduced number of working days in April and serious supply chain disruptions following the Japanese tsunami. Quarter-on-quarter growth is expected to rebound to 0.8% in the third quarter and the economy will grow at a consistently modest rate of around 0.5% to 0.6% until the end of 2012.

Inflation is expected to be higher in the autumn and into next year than previously forecast, mainly as a result of increases in utility prices due to take effect later this year. But as the impact of the VAT rise falls away, inflation is set to moderate during 2012 and fall back closer to the Bank of England’s 2.0% rate towards the end of next year.

The Bank is now expected to keep interest rates on hold until the first quarter of 2012 pending compelling evidence of a marked and sustained pickup in the economy. Modest interest rate rises of 0.25% are expected to begin in Q1 2012 through to Q4 taking the Bank rate to 1.5% by the end of the year.

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