Think-tank warns of ‘squeezed incomes’ as inflation rises

'Sterling's shaky performance this 'month provides a 'timely reminder that challenges lie ahead'
'Sterling's shaky performance this 'month provides a 'timely reminder that challenges lie ahead'
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Britain’s economy is set to enter a prolonged period of weaker growth as rising inflation and a slump in business investment take their toll, an influential think-tank will warn this week.

Revised forecasts from the EY Item Club are likely to stoke fears that the UK’s economic recovery could grind to a halt as the fallout from June’s EU referendum vote makes itself felt.

While exports still offer a potential “silver lining”, uncertainty surrounding Britain’s future relationship with Europe and the weaker pound’s impact on inflation risk a sharp slowdown in gross domestic product (GDP).

The EY Item Club, which is the only major economic body to use the UK Treasury’s forecasting model, is expecting GDP growth of 1.9 per cent this year, supported by strong consumer spending and low inflation. However, economists will warn that rising inflationary pressures and falling business investment could whittle that growth back to just 0.8 per cent in 2017.

Inflation, which has been running well below the Bank of England’s 2 per cent target for some time now on the back of record low interest rates, is forecast to accelerate to 2.6 per cent next year, before easing back to 1.8 per cent in 2018.

Of concern will be the think-tank’s prediction of a sharp decline in business investment over the coming year with only a modest recovery likely in 2018. It is forecasting GDP growth of 1.4 per cent in 2018.

Peter Spencer, chief economic advisor to the Item Club, will say in tomorrow’s autumn forecast: “So far it might look like the economy is taking Brexit in its stride, but this picture is deceptive.

“Sterling’s shaky performance this month provides a timely reminder that challenges lie ahead. As inflation returns over the winter it will squeeze household incomes and spending.

“The pressure on consumers and the cautious approach to spending by businesses mean that the UK is facing a period of relatively low growth. With activity in the domestic market flat, GDP growth will become heavily dependent upon exports next year.”

Recent reports have painted a mixed picture for the economy in the wake of June’s EU vote, with the powerhouse services sector defying expectations of a slowdown. However, official data on Friday showed that Britain’s construction industry was pummelled in August.

The Office for National Statistics said construction output dropped 1.5 per cent in August, month-on-month, compared with July’s 0.5 per cent increase.

Howard Archer, chief UK and European economist at forecasting group IHS Global Insight, said that the overall contraction in construction activity is likely to weigh down third-quarter GDP growth.