The British economy will escape a "double dip" next year, but households face a tight squeeze on living standards from higher-than-expected inflation, rising interest rates and tax rises, according to forecasts from a leading employers' organisation.
With a hike in VAT to 20 per cent coming on 4 January and consumer confidence hitting record lows, ministers will be especially concerned that the UK's fragile recovery could still be derailed by renewed crises in the eurozone. A sluggish property market and a drop in average house prices of 4 per cent in 2011 completes the gloomy economic outlook.
The Confederation of British Industry says the Bank of England will need to raise interest rates further and faster than previously thought, because of the impact of rising world commodity prices on inflation.
The bank rate, which currently stands at 0.5 per cent, is seen at 0.75 per cent by the spring of next year, rising steadily to 1.25 per cent this time next year and to 2.75 per cent by the end of 2012 is envisaged.
Even at such levels, however, rates would be low by historical standards. The upward trend in rates will put additional pressure on the 7 million mortgagors on variable rate deals linked to the bank rate, adding hundreds of pounds a month to mortgage repayments.
Ian McCafferty, the CBI's chief economic adviser, commented: "The pace of recovery in the UK economy has been slightly stronger over the past year than we and many others had expected, and somewhat faster than typical during the first year out of a recession. But we do not expect that rapid pace of growth to continue over the next two years of recovery.
"The big early kicker to growth from the turn in the inventory cycle has already passed and we are now starting to feel the impact of lower government spending... quarterly growth at the start of 2011 is likely to be very sluggish, although we do expect the recovery itself to stay on track."
In its latest economic forecast, the employers' organisation sees inflation peaking at 3.8 per cent in the first quarter of 2011, on the consumer prices index (CPI) measure. On the retail prices index (RPI) measure, which also takes account of accommodation costs, inflation will hit 5 per cent.
Policymakers at the Bank of England fear that if rising inflationary expectations become embedded in the public's mind they may need to re-establish credibility through modest rises in rates sooner rather than later. This week saw a sharp rise in such expectations for inflation, according to the Bank's own polling evidence.
"Very sluggish" economic recovery in the first months of 2011 will give way to only slightly faster growth in 2012, well below the pattern of recovery seen after previous recessions.
Public spending cuts, the withdrawal of monetary stimulus, upcoming tax rises, including another increase in employees' national insurance contributions in April, and worries about the eurozone will all conspire to hold back the economy.
By contrast, healthier growth in pay, investment and exports, albeit from modest beginnings, will help compensate, and unemployment is only forecast to rise to 2.58 million by the end of 2011, with the private sector creating sufficient new posts to compensate for job losses in government and local government. Flows of bank credit are expected to continue to be "subdued".
But "despite many risks to the outlook, and a forecast of particularly fragile growth at the beginning of 2011, the UK recovery is expected to be maintained", according to the CBI, which "still considers the risk of a double dip back into recession to be low".