Mixed blessings

The CBI’s economic forecast, out today confirms that the outlook remains one of healthy growth. But it also highlights the impact of government activity in driving labour market tightness, in turn underpinning inflation and interest rates.

Publishing its latest quarterly forecast, the CBI points to healthy economic growth of 2.7 per cent this year and 2.6 per cent next. Consumer spending growth is expected to ease this year but the negative impact on GDP growth should be partially offset by sustained strength in government spending and investment, allied to a better net export performance.

The upward revision in this year’s growth forecast since November – from 2.5 per cent to 2.7 per cent – is minor and reflects buoyancy at the end of last year, combined with changes in the profile of government spending taken from the Treasury’s Pre-Budget Report.

With government sector activity continuing to expand, concerns about the level of spare economic capacity, combined with a modest build up of inflationary pressures, mean the CBI has stuck with its assumption of one further interest rate rise, to 5.0 per cent in the late spring of 2005.

This rise in rates is predicted as CPI inflation is expected to rise gradually from the 1.4 per cent rate at the end of 2004 to finish just above the 2.0 per cent target by the end of 2006. At the same time, unemployment is forecast to fall further, and underlying earnings growth to pick up, over the course of the next two years.

Growth in consumer spending appears to be slowing as the impact of last year’s interest rate rises take effect and the housing market cools. With consumers’ reluctant to take on new debt, the savings ratio should edge up over the next couple of years with spending growth remaining subdued by recent standards.

Manufacturing output is expected to accelerate to 1.8 per cent this year, before slowing slightly to 1.7 per cent in 2006.

While exports are currently being hampered by high oil prices on global demand, the negative impact of this should start to recede from the middle of this year, at which point exports should start to grow more strongly.

Business investment growth is expected to be slightly slower in the short term as high energy and commodity prices are likely to eat into profit margins. However, strong government investment will continue to drive investment growth in 2005.

CBI Chief Economic Adviser Ian McCafferty said: “The economic outlook for 2005 and 2006 remains healthy, but the economy is now having to learn to live with full employment, and the risks of a pick-up in core inflation are rising. For individual businesses though, life remains tough, with profit margins under pressure and many still reluctant to invest.”

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