FOR almost 10 years, the UK economy grew robustly and the rate of inflation and the bank interest rates remained low and stable.

However, since the beginning of the current calendar year, things appear to have taken an uncertain turn. The growth rate continues to remain robust but the prices and interest rates seem to have been destabilised. This has made the job of the Bank of England, operating independently since 1997, rather tough. Therefore, it is tightening its monetary policy to discourage inflationary trends. And it does not seem to be impressed by the recent downward trend in the rate of inflation as it has not brought the interest rate down in response, perhaps expecting the CPI to jump back, if it did so.

Interest rates are likely to rise to 5.75 per cent this autumn to bring inflation back below target by the end of 2008, according to the latest quarterly economic forecast of the Confederation of British Industries (CBI).

With inflationary pressures rising over the last three months, the business group has factored a quarter point increase into the outlook, with a reversal to 5.5 per cent likely by the end of next year.

Higher borrowing costs mean slightly weaker economic growth which is now expected for 2008. The annual growth rate for 2007 remains unchanged at 2.9 per cent but next year's growth will ease to 2.4 per cent, down 0.2 per cent on the CBI’s March forecast.

Ian McCafferty, CBI Chief Economic Adviser, said: “Though not a foregone conclusion, a further interest rate rise now seems more likely than not, this autumn and we have built this into our forecast. Recent oil price rises, unexpected and sharp increases in food costs, higher than expected import prices and businesses rebuilding profit margins after last year's squeeze have all added to inflationary pressures.

“The economy will still enjoy above trend growth this year, with consumer spending remaining robust until the full effect of higher rates is felt later this year. Higher borrowing costs will make economic growth slightly weaker next year as consumer spending is reined in.

"This should allow the Bank (of England) to bring interest rates back down to 5.5 per cent in the second half of 2008. Despite the current speculation, we do not see the need for rates to hit the six per cent mark."

Other key points of the economic forecast include:

• Consumer spending will grow in 2007 by 2.8 per cent, 0.2 per cent higher than forecast in March, but will ease to 2.1 per cent in 2008, as higher borrowing costs squeeze disposable incomes.

• CPI inflation will end 2007 at 2.2 per cent, slightly higher than previously forecast, but will continue to edge lower into next year, falling below target by mid-2008.

• Continued strong economic growth internationally, combined with a slight depreciation in the pound means export growth is expected to be robust in 2008, outstripping that of imports. As a result, net trade is expected to become a positive contributor to GDP for the first time since 2005.

• Unemployment will continue to fall, from 1.68 million in 2006 to 1.65 million this year and 1.60 million in 2008.

• Business investment will grow by 5.9 per cent in 2007, but then slow to 3.7 per cent next year.

In March this year the CPI in the UK had risen more than one percentage point to 3.1 per cent against the target of two per cent for the year. This was estimated to be the highest rate of inflation in this country in the decade starting 1997. However, in a matter of two months things started cooling down and in May the CPI slowed to 2.5 per cent. This is said to be happening mainly because domestic energy bills are declining whereas they were going sharply up in the last quarter of 2006. In recent months, the domestic gas and electricity bills took a steep tumble from 24.9 per cent on March-to-March period to 9.5per cent last month.

The Bank of England in its inflation report for the month of May predicted that the CPI would come down below two per cent by early next year as a result. But there are no signs that the interest rates would also come down in sympathy because the sentiment for the intervening period still appears to be uncertain in the UK.

The economic growth rates in recent months in the UK have been higher than its recent annual average. This is more due to the robust world economy and higher rates of business investments all around than anything else. Also, there is higher demand for bank resources and the supplies are not lacking.

So, all this has combined to keep the sentiments uncertain about overall price pressure and therefore, it is felt within the financial and business circles here that the Bank of England would continue to keep a firm hand on the monetary policy. And the market is not ruling out the possibility of the interest rates going up to 5.75 per cent or even to 6 per cent in a matter of months from the current rate of 5.5 per cent.

Still, firms are optimistic that strong growth in demand and output will continue, helping them rebuild profit margins.

Over the past 12 months demand and output have grown robustly, and businesses expect the growth to strengthen over the coming year. This has lifted optimism about the business environment and firms hope that profit margins, which have been under pressure from energy and other costs, will improve further. Job creation is predicted to continue, though at a slower rate.

Doug Godden, the CBI’s Head of Economic Analysis, said: “This is another round of solid growth in orders, output and jobs, with the benefits enjoyed by the majority of regions.

“Firms remain confident about the outlook, and with the trend in profit margins improved, are looking to step up investment in equipment, innovation and training.

“Further price increases in the next 12 months may prove to be wishful thinking by some businesses, and it remains to be seen how far prices can be raised in an environment of higher interest rates.