Growth forecast downgraded as inflation takes toll

THE UK economy is at a "critical juncture" as it faces a dual threat from the consumer spending squeeze and the eurozone crisis, according to the latest think-tank to downgrade its estimates for growth.

The influential Ernst & Young Item Club believes high inflation will continue putting pressure on consumer disposable incomes for the rest of the year, while the Greek crisis was hanging over the world "like the sword of Damocles" and remained the biggest threat to UK financial stability.

Peter Spencer, chief economic adviser to Item Club, said: "The UK economy has hit a critical juncture. The risks to the world economy and the eurozone are plain to see."

The Item Club will tomorrow reduce its forecast for gross domestic product (GDP) growth this year from 1.8 per cent to 1.4 per cent - the same as the figure for 2010.

It said growth would remain "sub-par" next year at 2.2 per cent, but accelerate to 2.5 per cent in 2013.

The report comes just days after the Centre for Economics and Business Research revised its expectations for growth for this year to just 1.2 per cent and warned that the UK could be caught in a trap of anaemic growth for the following three years, as both investment and export growth slows.

Both estimates are now well below the 1.7 per cent forecast by the Office for Budget Responsibility used by the Treasury to calculate government finances, suggesting it may take longer to balance the books than Chancellor George Osborne expects.

However, the reports are optimistic compared to some predictions from the City last week, which suggested the UK could be heading back into recession

Citigroup and Scotia Capital each predicted a 0.2 per cent decline in GDP for the second quarter of this year, while JP Morgan forecast no growth, Royal Bank of Scotland predicted 0.1 per cent growth, and Barclays 0.2 per cent.

The Item Club said the risks to the recovery are associated with the imbalances that caused the recession in the first place.

While world trade and UK exports have bounced back from their deep recession, the unbalanced nature of the world economy leaves overseas markets in a precarious state.

Spencer said the uncertainty was dampening business investment, which was expected to grow by 8 per cent this year and 12 per cent in 2012 - well below its peak levels.

"It's certainly not about the cash, it's about the commitment," he said. "Investors and the business community are lacking the confidence to commit to investment. The longer the soft patch extends the greater the risk of relapse in the UK labour market will become."