Domestic and overseas markets have recovered nicely and the Ernst & Young ITEM Club predicts GDP growth of 1.4% this year and 2.2% in 2011. However, ITEM cautions that the outlook remains very uncertain, with opinion divided over the future prospects for the UK economy.

With businesses and consumers preparing for the government’s five year fiscal deficit reduction programme and further evidence that exports are levelling off due to a decline in global demand, it’s hardly surprising that the MPC is wrestling over the prospect of a second round of quantitative easing.

Concerns for the future of the UK economy ‘exaggerated’
Yet despite the obvious tensions within the economy, ITEM says that the concerns which have arisen on the risks of the UK economy overheating, or suffering a bout of deflation, have been exaggerated. ITEM predicts that CPI inflation will move below target from January 2012 as the VAT increase finally drops out of annual calculations, and holds firm on its view that interest rates will not go up again until 2014.

Peter Spencer, chief economic advisor to the Ernst & Young ITEM Club, says, “The economy is likely to slow over the winter following a surprisingly positive first half of the year, but I think this will be a soft-patch, not a double-dip.”

Housing market to double-dip through the winter
Spencer adds, “There are many forces weighing on the UK economy. Evidence is mounting that global demand is slowing, while the health of the banking system and its ability to support the recovery still remains in doubt. Household spending – despite showing some resilience this summer – is likely to buckle under the unrelenting pressure on disposable incomes, with credit remaining tight and the housing market now double-dipping.”

Peeling back uncertainty
The forecast is based on the assumption that one way or another the coalition’s ambitious spending reductions will be achieved. Spencer says that publication of the Comprehensive Spending Review (CSR) should help to reduce uncertainty and stimulate business investment, which is forecast to increase by 1.8% this year and accelerate to 9.0% in 2011.

“Wednesday’s announcement should peel away another layer of uncertainty from the economic outlook and encourage businesses to loosen the purse strings, in much the same way that the formation of the Coalition government and the June Budget did earlier this year,” he says. “Helping the UK out of recession has been a bit like peeling back an onion – removing one-by-one the risks to the economy in order to re-build business confidence.”

Cashed-out consumers
The Ernst & Young ITEM Club has long maintained that cashed-out consumers aren’t in a position to power the recovery. Indeed, for UK households, the outlook is bleak. The squeeze on consumer spending looks set to continue, with average earnings growth running below 2% and little prospect of a significant pickup while there is so much slack in the labour market. Unsurprisingly then, ITEM also says that real disposable incomes are due to fall by nearly 1% this year, with little recovery expected in 2011.

“Low wage growth and rising unemployment combined with the prospect of high inflation until at least the end of next year, means that the average UK household is in for a tough time,” Spencer remarks.

Future prospects remain positive
Clearly a lot still hangs in the balance for the UK economy and there are a number of downside risks that could come to the fore, not least the potential for the CSR to take demand out of the economy. But this was always going to be a slow protracted recovery.

Spencer concludes, “Things should start to improve towards the end of 2011. Until then, as we’ve said previously, economic recovery really is dependent upon the extent to which business and services organisations, whether they are in education, entertainment or whatever, can increase their overseas income flows as the home market stagnates.

“And while we expect a slowdown in export growth this winter, we remain confident that export growth will dominate imports next year, with net trade forecast to add 1.3% to GDP and another 0.6% in 2012, pushing the UK’s current account into surplus.”

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