The British Chambers of Commerce (BCC) today published its new Economic Forecast, ahead of the Bank of England’s Monetary Policy Committee (MPC) meeting on Thursday. The BCC forecast reduces expectations for UK GDP growth in 2011 to 1.9% (from the previous figure of 2.2%), but raises its prediction for 2012 growth to 2.1% (from 1.8%).

The downward revision to the 2011 growth forecast reflects the BCC’s assessment that the negative impact of the Government’s austerity plan will initially be more serious than previously envisaged; this is mainly due to lower house prices and other signs of financial fragility in the UK household sector. The worsening Eurozone debt crisis will also dampen UK growth prospects next year more than formerly expected.

The economy’s longer-term prospects are now more positive than a few months ago, because there is more evidence that rebalancing towards the private sector is taking place; our growth forecast for 2012 has therefore been raised. Britain’s future success will depend on the relentless pursuit of policies aimed at strengthening the private sector and improving the economy's productive potential. Promoting higher economic growth must be the government’s main policy priority.

The main features of the Forecast include:

The BCC forecasts GDP growth of 1.8% in 2010, 1.9% in 2011 and 2.1% in 2012. In our previous forecast we predicted growth of 1.7% in 2010, 2.2% in 2011, and 1.8% in 2012. If the Government’s deficit-cutting strategy achieves its aims, it could help create a leaner and fitter economy.

We now predict smaller net increases in UK unemployment than in the September forecast. We believe total unemployment will rise from 2.45 million (7.7% of the workforce) in July-September 2010, to 2.6 million (8.0% of the workforce) in the first half of 2012, a net increase of just over 150,000 in the jobless total.  However, the initial impact of the austerity programme may cause sharper temporary increases. In September 2010 we predicted a net increase of around 200,000.

We expect the Government’s deficit-cutting plan to be carried out broadly according to plan. The forecast envisages Public Sector Net Borrowing (PSNB) falling to £148.0bn (10.0% of GDP) in 2010-11, £120.1bn (7.8% of GDP) in 2011-12, and £93.0bn (5.8% of GDP) in 2012-13.

CPI inflation is expected to remain above 3% until the final months of 2011, but is likely to fall back to below the 2% target early in 2012. We predict CPI annual inflation of 3.2% in 2010, 3.0% in 2011, and 1.9% in 2012. For RPI inflation we predict 4.6% in 2010, 4.3% in 2011, and 2.9% in 2012.

We assume that the MPC will keep the Bank Rate at its current 0.5% level at least until Q3 2011. Given the risks of a setback to growth in the first 2-3 quarters of 2011, we expect the MPC to increase the Quantitative Easing programme from £200 billion to £250 billion before the middle of next year.

Commenting, David Frost, the BCC’s Director General, said:

“British business supports the Government’s determination to deal with the deficit, and accepts that painful measures are necessary. Reducing the deficit, with a clear focus on spending cuts, is vital in order to restore confidence, international credibility and stability. However, deficit reduction on its own will not deliver a sustainable recovery.

“There must be a relentless focus on ensuring that businesses are able to invest, export and create jobs. The Government must avoid at all costs new business taxes, and measures that damage initiative, enterprise, and innovation. This includes improving business’ access to finance, particularly for exports, and reviewing oppressive labour market regulations.

“British business is willing and able to drive the recovery. But it can only do so if the Government will back its words with deeds. Promoting stronger economic growth should be the Government’s main policy priority next year and beyond. 2011 must be a Year for Growth – in every area of the UK – with small- and medium-sized businesses leading the way.”

BCC Chief Economist, David Kern, added:

“UK GDP growth was very strong in the second and third quarters of 2010, and the pace of expansion should remain satisfactory with growth of 0.6% in Q4 2010. This will be sustained by the competitive sterling exchange rate, the continued effects of the earlier policy stimulus, and consumers attempting to beat the VAT increase.

“However, some of the factors driving growth in 2010 are temporary. The fiscal austerity programme entails risks, particularly in the next few quarters. We expect a sharp slowdown in the pace of UK growth starting in Q1 2011, in reaction to the VAT rise to 20% and as tough deficit-cutting measures are implemented. Consequently, year-on-year GDP growth, after rising to 3.0% in Q4 2010, is forecast to fall sharply to 1.4% in Q3 and Q4 2011, and stay below 2% in the early months of 2012.

“The UK economy appears sufficiently robust to avoid a new recession, and there are realistic hopes that policies aimed at rebalancing the economy towards the private sector will improve Britain's medium-term prospects. We have therefore upgraded our GDP growth forecast for 2012. Though the next few years will be difficult, if the deficit-cutting plan is implemented successfully, trend growth of UK GDP could increase to 2.5-2.7% per annum after 2015.

“The Bank of England cannot ignore the risk that if inflation remains around 3%, expectations could worsen, and its own credibility questioned. However, the MPC would be wrong to over-react. Inflationary expectations and wage pressures are under control at present. Threats of a setback to growth will remain more serious than risks of a surge in inflation during the next 12-18 months. We assume that the MPC will keep the Bank Rate at its current 0.5% level until at least Q3 2011. Given the risks of a setback to growth in the first 2-3 quarters of 2011, we expect the MPC to increase the QE programme from £200 billion to £250 billion before the middle of next year.

“The UK labour market is now much more flexible than in previous recessions. This greater flexibility, particularly the willingness of workers to accept wage reductions, has ensured that falls in employment, and rises in unemployment, in the 2008-09 downturn have been much smaller than in the recession of the early 1990s. Limiting job losses in the recent recession has been a positive development. However, with employment falling much less than output in 2008-09, UK productivity has recorded big falls. As the economy recovers, it is critically important that we recoup these productivity losses.”