A gradual return

The CBI's economic forecast out today suggests that the economy will pick up only gradually and will not return to its trend rate of growth until 2007.

The CBI's March forecast follows better-than-expected GDP growth in the last quarter of 2005, but suggests this recovery will not be sustained. And the return towards trend growth will rely on an interest rate cut being made in the next few months.

Over the next two years, demand will be supported by Government expenditure and by a continued resilient performance of key export markets. Consumer spending growth will remain subdued into 2007 because of modest growth in disposable incomes, higher energy and utility bills and other debt burdens.

The CBI's forecast also points to only modest growth in business investment this year and next. The organisation remains concerned that this will still leave investment close to its current record low share of GDP. The CBI has called for the Chancellor to rein back business taxes in this week's Budget to improve competitiveness and help revive corporate investment.

GDP growth for 2005 turned out 0.1 per cent higher than expected in November at 1.8 per cent, as a result of a better-than-expected final quarter. This base effect also results in the 0.1 per cent increase in the CBI’s forecast for 2006 growth, up to 2.3 per cent from November's 2.2 per cent.

Looking further ahead, GDP growth is forecast to be broadly in line with the trend rate at 2.5 per cent in 2007. But it does not exceed it, as in some other forecasts, as consumer spending continues to grow only in line with real household disposable income, which in turn continues to increase at a more subdued pace than in recent years.

Business investment will also begin to pick up from a very low base, but growth is forecast to be only modest over the next two years at 3.3 per cent, which is lacklustre compared to rates seen during the mid to late 1990s. A decline in manufacturing investment is forecast for this year, before it picks up again in 2007.

"Our forecast is for marginally faster growth in 2006 but still pegs it below trend, with slightly better news for next year. Consumer spending power continues to be constrained by subdued wage growth as well as higher utility and council tax bills,” said CBI Chief Economist Ian McCafferty.

He added: "More worryingly, in cash terms, Government spending is set to continue running at a faster pace than GDP. More efficient private sector activity - especially business investment - is being crowded out, harming our longer-term growth prospects.

"The Budget is the Chancellor's opportunity to lift his foot a touch from the Government's spending pedal and give the private sector the breathing space it needs to deliver stronger growth in the future.

"It is fortunate that the resilience of the world economy will help support growth over the next two years. But much also depends on the Bank of England’s decision on interest rates. The CBI believes there will be room for a quarter point cut in the coming months. Without it, growth will struggle to get back to trend in 2007 and inflation is likely to undershoot the Bank’s target rate of 2.0 per cent."

Growth in the OECD area is expected to be similar in 2006 (2.8%) and 2007 (2.6%) to 2005. As a result, net trade is set to be broadly neutral in its impact on

growth, as it was in 2005, but in strong contrast to the sharp negative contributions seen in some previous years.

Manufacturing output is expected to show some recovery in the response to resilient global demand. Having seen a contraction last year, output will grow by 0.6 per cent this year and in the next by 1.6 per cent.

Employment in manufacturing is, however, expected to continue to decline over the next two years. Other sectors will see some rise in employment but not sufficient to reverse the recent increases in unemployment.