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Economic growth will fall short, says IoD

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The UK economy will grow at a sluggish 1.2 per cent next year, a leading business group has predicted, a rate that is slower than official forecasts.

In its latest estimates for 2011, the Institute of Directors (IoD) pared back its previous prediction of 1.8 per cent expansion to just 1.2 per cent.

Weaknesses in the economy will lead to what the IoD describes as a square root sign recovery: a temporary spurt of growth in 2010 to be followed by a plateauing in 2011.

Were its analysis to be proven correct, the IoD said that the Chancellor may need to look at additional spending cuts or tax rises.

The IoD claimed that the robust rate of growth seen in the second and third quarters of this year will be counterbalanced by economic deceleration as fiscal tightening (the spending cuts) and household trends towards reducing debts take hold.

The Office for Budgetary Responsibility has been forecasting growth of 2.3 per cent for next year.

Previous predictions from the IoD had been anticipating a ‘L’-shaped recovery, in which the upward growth curve remained relatively consistent.

However, the business group said that the evidence of 2010 so far suggests that the recovery may be following another route: a few quarters of stronger growth where the economy grows in line with a normal cyclical bounce back but then levels off, giving a square root shape contour.

The report maintained that strong expansion in the middle quarters of 2010 represented the ‘up tick’ part of the square root cycle, with the level-off coming as a consequence of the legacy of the financial crisis, weak money supply growth, the fiscal squeeze and de-leveraging across the household sector.

Graeme Leach, the IoD’s chief economist, said: “After an extraordinary financial crisis, fiscal explosion and the introduction of unconventional monetary policy the level of economic uncertainty remains at a very high level.

“The effectiveness of traditional forecasting models – always questionable – is open to very serious doubt when they have little or no capacity to incorporate the effects of quantitative easing, and when the size and sign of fiscal multipliers is open to question in the wake of the financial crisis and exploding public debt and deficits.

“In such circumstances economic forecasting becomes what it always has been, an issue of feel and judgement.”