The CBI expects the UK economy to continue to grow, and at a slightly faster pace in 2010 than had been expected.

However, the pace of recovery looks to be more sluggish in 2011 than previously forecast, following measures announced in the emergency Budget to deal with the deficit.

The outlook for consumer spending next year is now weaker as households will have less disposable income due to ongoing high inflation, resulting from January’s VAT rise, and modest wage increases.

In its latest economic forecast, the CBI predicts that the UK economy will grow by 1.6% in 2010, up from 1.3% in its previous forecast in June. The slight upward revision reflects better than expected growth in the second quarter this year as companies began rebuilding their stocks.

The CBI has revised down its GDP forecast for 2011, to 2.0% from 2.5% in June. This takes into account the additional fiscal consolidation measures announced in the emergency Budget, which took place after the CBI’s June forecast.

Looking at quarter-on-quarter growth, the CBI expects the economy to grow by 0.3% and 0.6% in the latter two quarters of 2010, having achieved 0.3% and 1.2% growth in the first half of the year. Quarterly growth is then forecast to pick up gradually from 0.3% to 0.6% over the course of 2011.

Although the level of uncertainty around the forecast remains high, the CBI considers that a double dip back into recession is unlikely.

Richard Lambert, CBI director-general, said: “The degree of uncertainty around the outlook remains high, but our view is that the UK’s tentative recovery will be sustained, albeit with weaker levels of growth.

“The fragile nature of the recovery is why, in the forthcoming spending review, the Government must focus its scarce resources on those areas which most galvanise growth, namely infrastructure and capital investment.”

Although household spending is expected to receive a boost at the end of the year, as consumers seek to avoid higher VAT in January, growth in spending is forecast to be restrained next year. Consumer spending growth of 0.9% in 2010 is likely to be followed by an equally anaemic 1.0% in 2011.

Having stabilised this year, following record falls in 2009, the recovery in business investment will be fairly subdued, with only moderate growth next year.

Ian McCafferty, CBI chief economic adviser, said: “While the outlook for growth in 2010 has been lifted slightly, due to slightly faster economic activity in the second quarter of the year, the outlook for next year will be more restrained.

“The action to get the public finances back onto a sustainable footing will no doubt temper the recovery going into 2011.
“Consumer spending will be more constrained than previously thought, due to higher inflation resulting from next January’s VAT rise, and wage increases continuing to be modest.
“We do expect exports to grow at a faster rate than imports however, with net trade making a positive contribution to GDP growth during the coming 15 months.”

With VAT increasing to 20% from January, inflation is expected to remain above the Bank of England’s 2% target through to the end of next year. This is despite some downward pressure on inflation from spare capacity.

The Bank is likely to start raising interest rates later than previously expected, from next spring. Monetary stimulus will gradually be withdrawn, and rates are forecast to reach 1.25% by the end of 2011.

UK exports are expected to grow by 3.5% in 2010 and 6.4% in 2011, with net trade expected to make a positive contribution to GDP growth rates throughout the forecast period.

Unemployment is no longer expected to peak during the forecast period, but will rise at a more gradual rate, moving from an expected 2.49m at the end of this year to 2.62m at the end of 2011.

Public sector net borrowing is forecast to reach £141bn in 2010/11, before falling to £116bn in 2011/12, representing 9.5% and 7.6% of GDP respectively.