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EC forecasts stronger UK growth but warns on VAT rise

14th September 2010

The European Commission has revised upwards its predictions for economic growth in the EU, but has suggested that the UK's recovery may be hampered by the decision to increase VAT.

The EC is now expecting growth in the EU of 1.8 per cent for 2010, up from a previous forecast of 1 per cent, and of 1.7 per cent in the eurozone, up from 0.9 per cent.

UK growth is projected to be 1.7 per cent, up from 1.2 per cent.

The EC report said: "While activity is still expected to moderate in the second half of the year, the outlook is for a slightly improved quarterly profile compared to the spring forecast, due to the spill-over of some momentum from the second quarter."

However, the report also insisted that the recovery would remain fragile and would be uneven - the German economy is predicted to expand by a colossal 3.4 per cent ­- in various member states.

The EC offered a particular word of warning for the UK.

It noted that, although the rate of UK economic growth in the second quarter of the year had been double expectations, much had been driven by the turning of the inventory cycle and strong consumer spending. Net trade made only a neutral contribution to UK growth.

Of the UK's prospects, the report concluded: "Economic growth is expected to slow down in the second half of 2010. Although inventory investment is expected to increase further, the extraordinary boost to second-quarter growth from the turning of the inventory cycle will not be repeated in the third quarter."

The planned increase in VAT, from 17.5 per cent to 20 per cent, should provoke higher levels of consumer spending in the run-up to the January hike but then would dampen spending activity in 2011.

The report continued: "The announced increase in the VAT rate in January 2011 should encourage higher private consumption in the fourth quarter of 2010. This is expected to lead to some acceleration in growth in the fourth quarter, although it will also curtail economic activity in the first quarter of 2011."

Business investment in the UK is forecast to be held back by weak demand and continuing tight credit conditions, the EC added.