It makes a pleasant change to read a report on the UK economy that paints a positive picture. And the picture that the artists at Ernst & Young’s ITEM Club have been busy creating with their fine brushes, is as pretty as a picture of lilies in bloom. And it’s good news for those who want to see low interest rates, too. Is their optimism well founded?

Well, in a nutshell, this is what the report says. The austerity budget will mean emphasis will be shifted from the public sector to business. Investment and exports will take up the slack left by government spending. By the time the austerity drive sets in the recovery will be in full swing, and as a result the pain of fiscal cuts will be manageable. Meanwhile, interest rates will stay at the current rock bottom levels well into 2013.

Peter Spencer, chief economic adviser to the Ernst & Young ITEM Club comments: “The new coalition’s plans to cut the deficit are certainly ambitious. But the bulk of the additional tightening is set to come in the second half of the parliamentary term, when we believe that the recovery will be firmly entrenched and the economy should be able to deal with the headwinds from the Budget.”

Spencer adds: “On the assumption that the government is able to implement the overall reduction of £40 billion set out in the budget, we expect that UK growth will struggle to reach 1 per cent this year but will gradually speed up in the following years to give the UK a high-quality recovery based on trade and investment.”

As for rates, this is what the ITEM Club had to say: “High energy prices and the increases in VAT will keep CPI inflation above target over the next 18 months, but ITEM believes that it will then move well below 2 per cent as these effects wear off and spare capacity bears down on pricing decisions and wage bargaining.

“To prevent CPI inflation moving below 1 per cent it will be necessary keep the Bank base rate low at 0.5 per cent for much longer than the OBR and the markets have anticipated. The ITEM forecast suggests that the base rate will remain on hold until the end of 2013, although this is dependent on the assumption that the impending spending cuts actually come through.”

Peter Spencer said: “A base rate of 0.5 per cent will begin to look like the new normal.”

And finally there is business. Spencer said: “It is time for businesses to take advantage of the tax incentives presented in the Budget. This time the consumer is in no position to pull us out of recession, indeed the outlook for households continues to be bleak – what with pressures from the labour market, pay pauses and higher taxes there will be a major strain on real disposable incomes in the short term. The impetus for the economy has to come from business spending, private sector employment and entrepreneurial initiative. Without that response, it will certainly be very hard for the government to pull off the trick of retrenchment and recovery.”

The ITEM Club report is full of warnings. Warnings about how the European crisis could unravel, and hit us. Warnings about the fragility of the UK consumer. But, wearing his positive hat, Spencer said: “The emphasis on spending cuts rather than tax increases over the medium term reduces damage to incentives and increases the chances of success, as does the business-friendly nature of the tax changes. A reduction in the uncertainty around the fiscal and monetary policy outlook should also support investment and employment. However, this forecast – not to say the success of the coalition’s fiscal strategy – hangs critically upon a positive response from UK plc and the financial markets.”

The ITEM Club’s optimism may be justified. But …

The big snag is that just about every economy in the world is trying to adjust through putting more emphasis on exports. This is not viable.

The UK’s austerity drive may well be essential. It may well be that we have no choice but to cut, cut and cut some more. The problem, however, is that everyone else seems to be doing the same thing.

Above all, before the credit crunch the problem may actually have been that the fruits of capitalism were not being appropriately distributed. Corporate profits were occurring at the expense of wages. This is fine for individual companies, but when profits are racing ahead of wages across the world, demand will lag behind capacity. And the only way this gap can then be closed is via consumer debt. We fear that this underlying problem has not gone away.