Public spending cuts 'to hit growth but recovery will continue in 2013'

Published on Thursday 22 July 2010 13:00

DEEP cuts to public spending expected from the coalition government will slow UK economic growth over the next two years but will not choke off recovery in 2013, an influential report will say tomorrow.

But the Ernst & Young Item Club predicts a shallow 1 per cent growth in GDP this year despite figures last week which showed that GDP grew 1.1 per cent in the second quarter.

The economic report also dismisses fears of out-of-control inflation. Item says that although high energy prices and the increases in VAT will keep CPI inflation above target over the next 18 months, it will argue that inflation will move well below 2 per cent as these effects wear off and spare capacity bears down on pricing decisions and wages. Currently only one member of the Bank of England's Monetary Policy Committee, Andrew Sentance, has voted for a rate rise before last week' stronger-than-expected GDP growth figures, although this is expected to change as growth threatens to fuel inflation.

Item will argue that it will be "necessary to keep the Bank base rate low at 0.5 per cent for much longer than the OBR (Office for Budget Responsibility] and the markets have anticipated" and predicts the base rate will remain on hold until the end of 2013.

Peter Spencer, chief economic adviser to the Item Club, said: "A base rate of 0.5 per cent will begin to look like the new normal."

Item believes maintaining cuts in spending will lead to more sustainable high-quality growth from 2013 because it will be led by business investment and exports rather than public spending.

Despite the recent revival, Item argues that larger companies in particular are generally in a strong financial position with plenty of profitable opportunities for expansion.

But the report warns that finance directors will be more likely to want to pay down debt than loosen the purse strings for investment opportunities, slowing economic growth over the next two years.

Item says the "remarkably business-friendly" measures, such as reliefs for small business and projections for cuts in mainstream corporation tax, should encourage some investment but that the effort has to come from business.

Spencer said: "It is time for businesses to take advantage of the tax incentives presented in the Budget. This time the consumer is in no position to pull us out of recession, indeed the outlook for households continues to be bleak; what with pressures from the labour market, pay pauses and higher taxes there will be a major strain on real disposable incomes in the short-term.

"The impetus for the economy has to come from business spending, private sector employment and entrepreneurial initiative."