Legal & General warns of brake on growth in UK

L&G economist Tim Drayson said the VAT rise to 20 per cent in the New Year will crimp consumer spending.

"We are taking tough fiscal medicine right now, but at least it is voluntary," he said. "The VAT rise means there will be a drop-off in consumer spending. We see a weak first quarter and then a gradual strengthening.

"The UK consumer won't feel wonderful about life. There won't be much job creation and people won't see their purchasing power going up very rapidly," he said.

He added that the VAT hike in addition to Government pay freezes will act as a brake on growth.

"We need to see pretty strong private sector growth to offset the public sector," he said. "We doubt the private sector can grow strongly enough. Overall we think UK GDP growth will be around two per cent."

L&G believes the construction sector will be particularly vulnerable next year.

"There are already signs that orders are dropping off," said Mr Drayson. "We expect construction activity to have another lurch down, it will be a key drag on the economy next year."

With the economy expected to remain quite weak, L&G does not expect the Monetary Policy Committee to raise interest rates next year.

"I don't think we will get any long term change to policy," said Mr Drayson, referring to the Bank of England's interest rate setting committee.

L&G expects the FTSE 100 to close at around 6000 next year and said a number of companies will either grow or re-introduce their dividends. He added that big multi-national companies look like a good investment as they will benefit from the upturn.

Away from the UK, L&G has grave reservations about the new stimulus package being offered in the US.

"The current proposals will see a boost to US incomes in the first quarter," said Mr Drayson. "It's good news for growth in the short term. There won't be a squeeze on consumers, but it has its dangers. There is no real plan to address the deficits. No other country would be allowed to do this."

L&G believes the US will face some major hurdles in the long term.

"Exiting quantitative easing is likely to be messy and the US remains under pressure to address debt levels not dissimilar to several European countries already in crisis," said Mr Drayson.

L&G said global equity markets have almost fully recovered their losses since the collapse of Lehman Brothers, but they remain around 25 per cent off the peak levels achieved three years ago. It added that equities currently appear attractive relative to bonds, but this is more a reflection of the overvaluation of bonds rather than any cheapness in equities.