By Daniel Hunter

After a dismal start to the year, the UK can expect an Indian summer with the Ernst & Young ITEM Club forecasting that the economy will return to growth over the next six months, boosted by falling inflation and a pick-up in consumer spending.

According to the ITEM Club’s latest quarterly forecast, out today (Monday), inflationary pressures that have been battering household incomes are now easing much quicker than expected. Providing that commodity prices remain subdued, ITEM Club says that inflation should hit 1.7% by the end of the year, giving consumers extra cash in their pockets to spend on the high street.

However, the report warns that the fillip to consumer spending in the second half of the year will only enable UK GDP to mark time, with zero growth in 2012 as a whole. ITEM Club says that longer term, sustainable growth remains dependent on an improvement in the UK’s export performance and business investment. ITEM is forecasting 1.6% GDP in 2013 and 2.6% in 2014.

“Spiralling inflation has cut real wages by 7.5% over the last four years, but the squeeze is almost over," Peter Spencer, chief economic advisor to the Ernst & Young ITEM Club commented.

"Inflation is now coming back to heel, helped by the Chancellor’s decision to postpone the increase in fuel duty, falling energy and commodity prices, plus tax changes dropping out of the calculation.

“The boost to household finances and the subsequent pick up in spending should be enough to push the UK back into positive territory this year, but don’t expect a consumer led recovery further out. Longer term, consumers are going to be more focussed on reducing their debt burden rather than splashing the cash.”

According to the report, real disposable incomes are forecast to increase by 0.4% in 2012, before increasing by 1.5% in 2013. Consumer spending is expected to be flat for the year as a whole, with falls in the first half reversed in the second half, but stages a more convincing recovery in 2013, growing by 1.5%.

The latest set of labour market figures from Q1 2012 showed a marked improvement in levels of employment, however the ITEM Club report warns that sluggish GDP growth is likely to reverse this positive trend. Unemployment is expected to hit 8.6% by the end of the year, peaking at 8.7% by 2013.

“It’s going to be difficult for the private sector to create jobs at its current rate and to compensate for losses in the public sector," Spencer added.

"With the size of the workforce continuing to increase, the unemployment rate is likely to nudge up. This will also have a knock on effect on pay settlements, weakening employees negotiating power and keeping earnings growth subdued for some time yet.”

With consumers focussing on retrenching, ITEM Club maintains its long held view that sustainable future economic growth lies in the hands of UK Plc, driven by exports and business investment. Despite the recent disappointing trade figures, ITEM says the outlook has ‘cheered up’ a bit since its last quarterly forecast in April.

“The Eurozone crisis remains a major risk to the forecast, but it is just possible that the EU summit in June, together with the tough new fiscal rules agreed in December, have laid the foundations for a gradual revival of business confidence - providing the proposals go ahead as planned. Closer to home, the Treasury’s ‘funding for lending scheme’ also looks promising and should help to free up credit flows," explained Spencer.

“We are expecting net trade to contribute very little to GDP this year, just 0.1%, but once the concrete has set, the contribution to growth should build steadily.”

An improving outlook for world trade and business confidence is also expected to lead to an uptick in business investment. ITEM Club is forecasting growth of 4.3% this year (artificially inflated by last year’s weak first quarter) and 3.4% in 2012.

Business investment will only return to pre-recession peaks in 2015, according to the report, but Spencer says there is a chance that businesses could surprise on the upside.

“The prospect of a durable UK recovery remains heavily dependent upon confidence in financial and business communities and it’s is going to take time to re-build. However, a resolution of uncertainty about the Euro could transform the outlook, pushing company spending up much faster than forecast,” concluded Spencer.

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