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Economic recovery remains 'fragile'

The UK's economic recovery, although in progress, is fragile and could be put at risk by the eurozone debt crisis and turmoil in the financial markets, the British Chambers of Commerce (BCC) has warned.

In its latest economic forecast, the BCC said that it has raised its prediction of UK growth to 1.3 per cent for 2010 but has revised down its expectations for next year because of medium-term problems.

The BCC urged the Bank of England to keep interest rates low for a prolonged period in order to encourage business investment.

The business group's advice is in sharp contrast to the OECD, the west's leading think-thank, which recently called for an increase in borrowing costs this year to tackle the threat of rising inflation.

The BCC report downgraded its growth forecast for 2011 from 2.1 per cent to 2 per cent.

It predicted that unemployment will continue to climb over the next 12 months but at a much slower pace.

The new forecast envisaged that unemployment will rise from 2.51 million to a peak of 2.65 million (8.4 per cent of the workforce) in the first quarter of 2011.

According to BCC estimates, CPI inflation probably peaked in April this year, but the new report suggested that it will remain above 3 per cent until the first quarter of next year. RPI inflation is forecast to average 4.8 per cent in both 2010 and 2011.

The BCC said that it hoped the Bank of England would hold interest rates at 0.5 per cent until November 2010, rising moderately after that to 1 per cent before the end of 2010 and to 2.5 per cent by the end of 2011.

The report also assumed that VAT will be raised to 20 per cent within the next 18 months, possibly in two stages, with an increase to 18.5 per cent in April 2011 and a further increase to 20 per cent in the autumn of 2011.

David Frost, director general of the BCC, said: "The UK economy is now recovering. But, the improvement is fragile, businesses large and small are still facing considerable pressures, and there are significant risks posed by the current crisis in the eurozone.

"To ensure this recovery lasts, the government must demonstrate an unwavering determination to support the vital role of wealth-creating businesses. Rebalancing the economy towards the private sector must be at the very heart of June's emergency budget - with businesses encouraged to invest, grow and create jobs."

Mr Frost went on to say that the new coalition government must avoid new business taxes and measures that might damage enterprise and entrepreneurship.

He warned that very careful consideration must be given to plans for changes to capital gains tax and to the possible abolition of certain corporation tax allowances.

Mr Frost expected VAT to rise but added that it should only be increased in conjunction with a full reversal of the 2011 employer National Insurance hike.

The BCC's chief economist, David Kern commented: "After two consecutive quarters of positive UK economic growth, the risk of an immediate relapse is less severe. However, the recovery is still weak, and it would be unwise to disregard the threat of a double-dip recession. The crisis in the eurozone and turmoil in the global financial markets threaten to dampen the UK's growth prospects.

"The government's decision to adopt forceful measures to deal with the budget deficit will help to restore market confidence and underpin Britain's AAA credit rating. A credible deficit-cutting plan and a freeze in the total public sector wage bill should be announced immediately."

But Mr Kern counselled that significant additional fiscal tightening, beyond the £6 billion already announced, should only be implemented when the recovery is more secure.

He said: "Following the modest slowdown in Q1 2010, we expect relatively strong GDP growth in the next few quarters. But, the factors driving the early stages of the recovery are temporary. Longer-term growth prospects are weak. The need to slash the budget deficit, strengthen the enfeebled banks, and reduce personal debt will limit growth.'

Mr Kern foresaw that long-term growth may be below trend, averaging just under 2 per cent per year for the next four to five years and considerably less than the 2.7 per cent average growth recorded in the period 2003-07.

He concluded: "Unless our labour market remains flexible and adaptable during the recovery, there is a risk that low productivity will persist, damaging the UK's medium-term growth prospects. To achieve a sustainable improvement in Britain's productive potential, recent adverse trends in the labour market must be reversed. Inactivity needs to decline, full-time employment must grow, and private sector employment has to increase."