Although the UK’s economic recovery is underway, the British Chambers of Commerce’s latest Economic Forecast warns that the situation remains fragile, and the risks of a relapse cannot be ignored. The BCC claims that the worsening eurozone debt crisis, and upheavals in global financial markets, will heighten the threats facing the UK.
While the business group has raised its GDP growth forecast for this year, to 1.3%, it has reduced growth expectations for 2011 because of increased medium-term obstacles.
Unlike the OECD, which has called on the Bank of England to sharply increase interest rates next year to mitigate the risks of higher inflation, the BCC is urging the Monetary Policy Committee to keep rates low for a prolonged period, which will enable firms to invest.
The BCC also argues that unless the coalition government creates the best possible business environment, which allows companies to drive a lasting recovery, the UK risks a period of economic stagnation.
The main features of the economic forecast include:
· We are now forecasting positive UK GDP growth of 1.3% in 2010 and 2.0% in 2011. In March, the BCC predicted growth of 1.0% in 2010 and 2.1% in 2011. The 2011 forecast was revised down because the obstacles to a sustained medium-term recovery are now greater.
· Unemployment will increase in the next 12 months but at a much slower pace. We also expect modest falls in employment. The new forecast envisages that unemployment will rise from 2.51 million to a peak of 2.65 million (8.4% of the workforce) in the first quarter of 2011.
· The forecast assumes that the new coalition government will adopt more forceful measures to cut the UK’s budget deficit, and predicts bigger declines in public sector net borrowing, to £147bn (9.9% of GDP) in 2010-11, and £116bn (7.5% of GDP) in 2011-12.
· The BCC’s forecast assumes that VAT will be raised to 20% within the next 18 months - probably in two stages: an increase to 18.5% in April 2011, and a further increase to 20% in the autumn of 2011.
· CPI inflation probably peaked in April this year, but the new forecast envisages that it will remain above 3% until Q1 2011 - and above the 2% target until Q1 2012. In annual average terms we forecast CPI inflation at 3.3% in 2010 and 2.9% in 2011. RPI inflation is forecast to average 4.8% in both 2010 and 2011.
· We expect the MPC to hold interest rates at 0.5% until November 2010. Thereafter, we expect modest increases to 1% before the end of 2010, and to 2.50% by the end of 2011. The Quantitative Easing programme is likely to be maintained at £200 billion for the remainder of 2010 and will then be scaled down gradually during 2011.
Commenting, David Frost, Director General of the British Chambers of Commerce, said:
“The UK economy is now recovering. But, the improvement is fragile, businesses large and small are still facing considerable pressures, and there are significant risks posed by the current crisis in the eurozone.
“To ensure this recovery lasts, the government must demonstrate an unwavering determination to support the vital role of wealth-creating businesses. Rebalancing the economy towards the private sector must be at the very heart of June’s emergency budget – with businesses encouraged to invest, grow and create jobs.
“The coalition must avoid new business taxes and measures that might damage enterprise and entrepreneurship. They will have to think very carefully about what their exact plans are around Capital Gains Tax and the scrapping of certain corporation tax allowances that incentivise investment.
“We do expect VAT to rise, but it should only be increased in conjunction with a full reversal of the 2011 employer National Insurance hike. If any increase in NICs is allowed to go ahead, it will act as a handbrake on job creation.”
BCC Chief Economist, David Kern, added:
“After two consecutive quarters of positive UK economic growth, the risk of an immediate relapse is less severe. However, the recovery is still weak, and it would be unwise to disregard the threat of a double-dip recession. The crisis in the eurozone and turmoil in the global financial markets threaten to dampen the UK’s growth prospects.
“The government’s decision to adopt forceful measures to deal with the budget deficit will help to restore market confidence and underpin Britain’s AAA credit rating. A credible deficit-cutting plan and a freeze in the total public sector wage bill should be announced immediately. However, significant additional fiscal tightening - beyond the £6 billion already announced - should only be implemented when the recovery is definitively more secure.
“Following the modest slowdown in Q1 2010, we expect relatively strong GDP growth in the next few quarters. But, the factors driving the early stages of the recovery are temporary. Longer-term growth prospects are weak. The need to slash the budget deficit, strengthen the enfeebled banks, and reduce personal debt will limit growth. Over the next four to five years, growth in GDP is likely to average just under 2% per year - considerably less than the 2.7% average growth recorded in the period 2003-07.
"Better-than-expected labour market developments since mid-2009 mask some worrying trends. Inactivity is increasing at a rapid pace, full-time employment is falling, and private sector employment has declined sharply. With employment falling much less than output in the recession, productivity has recorded very big falls.