UK Economic Growth Will Beat Expectations: Industry Group

Matt Clinch | CNBC

The U.K. could post better-than-expected growth numbers over the next three years, with a strong service sector propelling household consumption and business investment, according to business lobby group, the British Chambers of Commerce (BCC).

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In its second quarter economic outlook, the BCC upped its gross domestic product (GDP) growth forecast for 2013, 2014 and 2015, and said the service sector was likely to outperform other sectors.

"We have constantly said that earlier fears of a triple-dip recession were misguided and risked damaging confidence unnecessarily," said John Longworth, the BCC's director general, on Friday.

(Read More: No Triple-Dip: UK Economy Fears Ease)

The BCC raised its growth outlook for the U.K. this year to 0.9 percent, up from 0.6 percent. In addition, it increased its 2014 forecast to 1.9 percent, and its 2015 outlook to 2.4 percent.

"The upward revision is mainly due to higher-than-expected GDP growth in the first quarter of 2013, and a stronger recovery in service sector output and consumer spending. Although U.K. growth is forecast to remain modest until 2015, there will be a gradual medium-term improvement," said the BCC in its report.

(Read More: UK Business Confidence Bouncing Back: Survey)

According to the Office for National Statistics' second estimate, U.K. GDP grew by 0.3 percent in the first quarter of the year, with consumer spending and stock building the main contributors to growth. In comparison, the economy contracted by 0.3 percent in the final quarter of last year.

Meanwhile, U.K. service sector data for April showed the strongest increase in business activity in eight months, after a steady improvement since the start of the year.

The BCC forecast household consumption would rise by a healthy 1.3 percent in 2013, and would continue to increase over the following two years. "A slightly stronger recovery than predicted in our March forecast, as falling CPI (consumer price index) inflation, from the third quarter 2013 onwards, will ease the squeeze on real incomes," it said.

The lobby group warned though that an uptick in inflation could harm the U.K.'s economic recovery.

"The two main risks facing our forecast are worsening euro zone prospects, and an upturn in U.K. inflation, which would squeeze real income, and could harm growth. Any attempts to boost exports by encouraging a weaker pound (for instance, by extending quantitative easing) could prove counter-productive, as the damage caused by imported inflation is likely to outweigh the small benefits to exporters," said David Kern, BCC's chief economist.

However, Pimco said on Wednesday that currency devaluation, accompanied by higher inflation, would be the most effective way for the U.K. to generate nominal growth.

At the conference, Mike Amey, Pimco's head of sterling portfolios, said incoming Bank of England Governor Mark Carney should aim to devalue the pound by 10-15 percent against the dollar, taking it from around $1.50 to $1.37.

"I do not think it is a big ask, on the secular horizon. It is easy to depreciate the currency as the U.K. economy is relatively open, and it is small, so depreciation has less effect on the global economy," Amey said.

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Kern stressed that efforts to rebalance the economy towards exports should be supported by measures such as greater funding for trade promotion, and connecting businesses to overseas customers.

Exports already constitute a high proportion of U.K. GDP, at around 30 percent. A declining but significant chunk of exports, roughly 50 percent, are bound for mainland Europe.

The BCC was less positive about the prospects for the U.K.'s unemployed, forecasting unemployment would reach 2.65 million, or 8.1 percent of the workforce, by the third quarter of 2014.

"We expect employment to increase in the next 18 months, but any new jobs created will not be enough to absorb the increase in the number of economically active people," wrote the BCC.

An upsurge in unemployment could prove worrying for the country's Conservative-led coalition government, as some analysts have attributed the U.K.'s resilience to the political and social instability seen elsewhere in Europe to its comparatively low level of unemployment.

"The degree of political and social cohesion in the U.K. is high given the worst recession in 50 years… Unemployment has stayed down and participation rates in particular have remained stable," Amey said.

(Read More: Spain Unemployment Rate Hits Record 27.16%)

In its report, the BCC forecast the Bank of England would hold baseline interest rates at the record-low of 0.5 percent until the first quarter of 2015, before upping them to 0.75 percent in the subsequent quarter and 1 percent by year-end.

In addition, it predicted the Bank would increase its asset purchase program by 50 billion pounds to 425 billion pounds ($640 billion) in the third quarter of 2013. "Our view is that increasing quantitative easing at the moment is unnecessary, and could be counter-productive," the BCC said.

(Read More: Pimco's Bill Gross: Beware of 'Monetary Red Bull')

—By CNBC's Katy Barnato