VAT hike and spending cuts set to hit in 2011, with CBI predicting slowdown

THE UK economic recovery will slow down in the early months of 2011 as consumers absorb the impact of government spending cuts, and higher VAT.

The warning comes today from the CBI as its downgrades its growth forecast for the first quarter of next year from 0.3 to 0.2 per cent. However it said a double-dip recession would be avoided as the economy picks up later in 2011.

The sluggish outlook is due to the probable impact of public-sector job cuts and the increase in VAT from 17.5 to 20 per cent next month. The economy will then grow by 0.4 per cent in the second quarter and 0.5 per cent for both quarters in the second half of the year, according to the CBI. The figures would be lower than in 2010, which saw growth of 0.4, 1.2 and 0.8 per cent in the first three quarters. The CBI expects the economy to have grown by 0.5 per cent in the final quarter.

It also made its first prediction for 2012, when expected growth of 2.4 per cent would be more slower than typical for the third year of a recovery. The subdued outlook for 2012 is due primarily to increased pressures on consumers, as incomes fall, unemployment remains high and households absorb the impact of a possible increase in interest rates. It also warned that inflation would be higher than previously forecast throughout 2011. The 4 January increase in VAT will ensure that inflation exceeds the Bank of England's 2 per cent target throughout the year. It may fall below the target early the following year but will end 2012 at 2.4 per cent, said the CBI.

Ian McCafferty, chief economic adviser to the CBI, said: "Quarterly growth at the start of 2011 is likely to be very sluggish, although we do expect the recovery itself to stay on track. What is striking is how little we see growth accelerating in 2012. Typically, by the third year of a recovery, growth would be more robust than we expect for either 2011 or 2012," he said.

His caution was echoed by the latest household finance index from researchers Markit, which said a fifth of households saw their debts increase for the third successive month in December as consumers compensate for a drop in income.

Markit economist Tim Moore said: "The UK economy looks to have avoided a double-dip recession in 2010, but there is little evidence that household finances have even begun to recover. People have seen their spending power eroded by stubbornly high inflation throughout the year and little in the way of income growth to compensate."