A pick-up in the UK economy over the last quarter will drive GDP growth of 2.4% this year and is expected to increase to 2.5% in 2007. This is good news for business except that rising energy cost will drive inflation up and the Bank of England may be tempted to raise interest rates.
According to the CBI's economic forecast shows on 19 June headline inflation, will exceed its 2% target throughout the period. It will peak at 2.5% in the first quarter of next year before falling back over the remainder of 2007.
But, the CBI says, the Bank of England can still deliver its inflation-mandate without raising interest rates as energy prices are expected to stabilise and domestic pressures to remain under control.
The upward revision in annual GDP growth for 2006 (up 0.1% on March's forecast) is based on a stronger international economic performance than previously assumed, a corresponding demand for UK goods and services exports, and the greater government consumption revealed by the Treasury in the spring.
An improved export situation compared to 2005 will help manufacturing output grow by 1% in 2006 and by 0.7% next year, the CBI forecasts. This compares with a contraction of 1.1% last year. The largest part of the UK economy, the service sector, will continue to perform robustly, with a predicted growth rate of 2.7% this year and 2.8% in 2007.
Household disposable income, in real terms, is expected to grow modestly, at 2.1% in 2006. This reflects subdued growth in earnings and employment in the wake of last year's weaker general economic performance and higher energy prices.
Household consumption growth is expected to grow at 2.2% in 2006, and 2.3% the following year. It will be helped by improvements in the housing market but rising unemployment - a forecast borne out by last week's unemployment figures - will constrain average earnings growth and suppress willingness to spend.
Total fixed investment for 2006 and 2007 is forecast to grow slightly more slowly than expected in March as projected government investment is much weaker for both years. Business investment growth will be modest by past standards, although up on March's forecast.
CBI Chief Economic Adviser, Ian McCafferty, said, "The economy is now expected to grow slightly more quickly in 2006 than we previously thought, reflecting the better prospects for exports and greater government consumption.
"There will also be some of the long-desired rebalancing in the economy through 2006 as household consumption remains constrained and government spending slows relative to recent years, with growing export demand off-setting these factors.
"The trade-off between growth and inflation though worsens in 2007. Inflation, in consumer price terms, will stay above the two per cent target to the end of 2007, although by the second half of the year it will ease back towards this level.
"Energy prices have rocketed but core inflation pressures are expected to be limited by the low growth of wage settlements, rising unemployment, and the limited ability of businesses to pass higher costs on to customers.
"Given the temporary nature of the inflation overshoot, the Bank can still deliver its inflation mandate without the need to change base rates."
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