CBI slashes growth forecast for 2009 to 1.3 per cent

The Confederation of British Industry has slashed its forecast for the economy next year, predicting that rising prices and falling demand will push growth to its lowest since the recession of the early 1990s.

Britain's biggest employers' group has left its growth expectations for this year virtually unchanged. But it has slashed its forecast for 2009 to 1.3 per cent from 1.7 per cent.

Inflation will peak at 3.8 per cent in the third quarter of this year and will not fall below 3 per cent until the end of the first quarter of 2009, the lobby group said.

The slowdown in consumer spending is set to intensify next year, with consumption growth slumping to 0.7 per cent – the lowest since 1992. "Households will see little or no growth in their disposable income," the CBI said.

Adding to the misery, unemployment will reach almost 1.8 million and public borrowing will balloon to £47.8bn, a figure which would almost certainly break the Government's "fiscal rules".

Richard Lambert, the CBI's director general, said: "The oil price has continued to rise strongly, roughly doubling since the spring of 2007. This has squeezed household incomes and companies' profit margins, and has also made it much harder for the Bank of England to cut interest rates in the face of the economic slowdown."

Businesses' confidence in their own trading prospects plunged in May, a Lloyds TSB survey showed. Confidence is at the lowest since the bank started its survey in 2002.

BDO Stoy Hayward, the accountancy firm, also increased its projection for business failures over the next two years, with all sectors feeling the strain of higher prices, less capital and slower growth.

But Mr Lambert stressed that the CBI expected the economy to keep growing and that Britain should not talk its way into a recession-inducing collapse in sentiment.

The CBI's predictions came as the Bank of England warned that there could be no let-up by central banks in the battle against inflation.

In the Bank's latest quarterly bulletin, Charles Bean, the Bank's chief economist, examining the last decade and a half, "improvements in monetary policy made some contribution to the greater macroeconomic stability ... by anchoring inflation expectations. But an important lesson ... was that the anchoring of inflation expectations cannot be taken for granted – it depends on the ... vigilance of central banks".

The G8 Group of major economies warned at the weekend that surging commodity prices could replace the credit crunch as the main threat to the global economy. With oil and food prices rocketing, central banks are moving towards tightening monetary policy even as global growth slows.

UK inflationary expectations, as measured by the Bank's own surveys of public opinion, are running at their highest level since 1999. Against an official rate of inflation of 3 per cent in the Consumer Price Index, and with the older, more familiar Retail Price Index showing 4.2 per cent inflation, the public perception is that inflation is in fact 4.9 per cent.

The Bulletin states: "Since 2007, reported perceptions of current inflation have increased by more than can be explained by movements in the official headline inflation measures.

"This may reflect differences in individual households' inflation experiences, households putting greater weight on more recent price changes (e.g. the increases in household energy costs), or an increase in media reporting on food and energy price inflation."

Inflationary expectations are regarded by the Bank's Monetary Policy Committee as a "key factor" in setting interest rates, and adverse developments here and in "factory gate" inflation have led many to expect the next movement in British interest rates to be upwards. The markets have priced in two quarter percentage point rises by the end of the year.

The Bank suggested that the worst could be over for the credit crunch. "Towards the end of the review period, market sentiment generally improved, in part reflecting measures by a number of central banks to provide liquidity against a wider range of assets than previously.

"Equity markets recovered a little and corporate credit spreads narrowed slightly. Financial sector counterparty credit risk also appeared to subside as banks sought to raise fresh capital."