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Recovery ahead, but VAT rise could dampen spending

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The UK economy is on course to emerge from the recession in the second half of the year, the CBI has predicted in its latest forecast.

But the business group also warned that the recovery will be fragile and that the planned reversion to the old rate of VAT at 17.5 per cent could slow down consumer spending in the early part of 2010.

According to the CBI, UK GDP will see growth of 0.3 per cent in the third quarter of this year and 0.4 per cent in the fourth as consumers dip into their pockets while the VAT rate is still at its present 15 per cent.

However, the reintroduction of the 17.5 per cent rate could quell spending levels after the New Year. As a result, 2010 should start with very weak growth of only 0.1 per cent in the first quarter and 0.3 per cent in the second.

Businesses may start rebuilding their stocks but will probably only do so in a cautious manner.

Overall, the CBI estimated that the UK economy will shrink by 4.3 per cent in 2009 and will expand by 0.9 per cent in 2010.

Inflation may show signs of rising in early 2010 before settling back below the Treasury target of 2 per cent for rest of the year.

The CBI also forecast that the Bank of England would consider lifting interest rates, perhaps to as high as 2 per cent by the end of next year.

Richard Lambert, the CBI’s director-general, said: “The outlook is improving as the UK draws strength from quantitative easing, a weak pound and a recovering global economy. Although growth this quarter should mark the end of the recession, conditions in the UK will remain tough for some time yet, and it is difficult to see where demand growth will come from.

“Firms that have run down their stocks will now be starting to raise output to meet demand, and consumers are likely to bring forward spending before VAT rises. But once these two boosts are out of the way there is no clear driver of robust economic growth into 2010. Growth next year will remain very weak, while job losses will continue and household consumption will stay tightly squeezed.”