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UK needs companies to spend more of their £50bn war chest

Item Club calls on business to invest more of its cash reserves to get the economy moving

Companies are starting to invest in their businesses again, but the economy will only recover fully when they loosen their grip even more, according to the Ernst & Young Item Club quarterly forecast, published tomorrow.

But Peter Spencer, Item's chief economist, warned that any recovery is dependent on interest rates being kept as they are so that businesses will have a stable environment to operate in.

"The importance of companies releasing some of the cash they have stockpiled over the recession cannot be underestimated," he said. "And with consumers still under pressure, we're unlikely to see a durable recovery until UK Plc starts increasing investment or returning profits to shareholders through dividends."

But Mr Spencer reckons the stage is set for a revival in business spending and forecasts that investment will increase by 12 per cent this year, and by 14 per cent in 2012. Over the past few weeks, surveys from the CBI and the British Chambers of Commerce, have also demonstrated a new confidence.

British companies are estimated to have been storing about £50bn since the beginning of the recession three years ago. Investment spending fell by 28 per cent from early 2008 and although it grew by about 12 per cent last year, this was from a low base.

"The purse strings are starting to loosen, with some spending on vehicles and other easy asset purchases," Mr Spencer said. "If UK companies want to increase their capacity and capitalise on the opportunities that come from an improving world economy, they will need to extend spending to plant and machinery, buildings and overseas markets." But, he warned, "If corporate treasurers continue to build up the cash pile rather than the business, they will find themselves being bought up on the cheap by predators."

Based on Item's forecasts, Mr Spencer said the Chancellor is on course to meet the fiscal target of balancing the books by the end of the current Parliament. GDP will grow by just 1.8 per cent this year, before rising by 2.3 per cent in 2012 and 2.7 per cent in 2013.

But Item Club warns that raising interest rates before there is reliable evidence that the corporate recovery is fully under way could have disastrous consequences. Although many economists are predicting an interest rate rise when the Bank of England's Monetary Policy Committee meets next month, the Item Club argues this would be counter-productive.

Mr Spencer predicts that inflation will naturally ease next year when the latest VAT hike and other temporary effects are taken out of the index. "A rate rise would be perverse at this stage, merely adding to the intense pressure on UK consumers, as well as increasing the RPI and risking a rise in wage settlements," he said.

Item is also optimistic about exports – forecasting a rise of 9.9 per cent this year after strong trade figures in the first two months of the year.