The UK economy will benefit from falling inflation and lower interest rates in the second half of the year, boosting growth and allowing the government to offer pre-election giveaways, according to a study by a leading forecaster.

Handing Rishi Sunak a new year boost, the advisory business EY Item Club, which is sponsored by the accountancy firm EY, said its winter forecast showed that a long period of economic stagnation “should begin to fade this year as falling inflation, potential interest rate cuts and tax reductions create momentum for growth in 2024 and 2025”.

Sunak and the chancellor, Jeremy Hunt, hinted last week that a budget statement in March was likely to include tax cuts, building on the reduction in national insurance that was promised in last November’s autumn statement and which took effect on 6 January.

Further tax cuts could feature in the 2024 autumn statement before a general election expected before the end of the year, if the recovery proceeds as predicted.

The report shrugged off the likelihood of a recession in the second half of last year and the possibility of a further three months of negative growth in the first quarter of 2024, saying the underlying signs of a recovery would soon take effect.

An increase in gross domestic product of 0.7% in 2024 made in the firm’s autumn forecast was upgraded to 0.9%, while the UK economy is now forecast to grow by 1.8% in 2025, up from the 1.7% predicted in October.

Last year’s growth was downgraded from 0.6% to 0.3%, emphasising a loss of momentum in the second half of the year owing to persistently high inflation and sharply higher interest rates.

Yet a recession is still possible if the economy is shown to have in the fourth quarter of 2023 after contracting by 0.3% in the third quarter. Several economists said last week that a surprise 3.2% drop in retail sales in December revealed a level of weakness in consumer spending that could drag the economy backwards in the fourth quarter.

Financial markets expect the situation to improve once inflation – which averaged above 6% in 2023 – falls as expected to 2% by April, and for the Bank of England to begin cutting interest rates in June.

A report by Lloyds Bank found that seven out of 14 sectors of the economy reported growing demand, as measured by new orders, in December 2023, more than twice as many as in November 2023.

A bounceback in the moribund property market, high levels of demand for flights and holidays and rising disposable incomes after a long period of decline were all credited with giving business a lift in confidence.

“Business optimism reached the highest level since May as 12 out of 14 sectors reported higher confidence levels about their output prospects for 2024 compared to the same time the year before,” the report said.

Simon French, chief economist at stockbroker Panmure Gordon, said that despite fears of a recession last year and weak Christmas shopping figures, the UK’s economic outlook had “improved markedly” over the last 12 months.

The EY Item Club said interest rates should fall from 5.25% to 4% by the end of the year.

Martin Beck, the club’s chief economic adviser, said: “Although it remains possible that the UK may have slipped into a technical recession in the fourth quarter of 2023, the mood music around the economy is justifiably improving.

“High inflation and expensive borrowing costs have been two of the biggest obstacles to growth recently and, with both showing encouraging signs of subsiding, prospects for late 2024 and beyond appear brighter.”

However, he warned there were risks that his forecast could be undermined by global events. “Ongoing geopolitical tensions could push up energy prices, which may slow the decline of inflation and increase costs for households and businesses.

“Plus, while the Bank of England is expected to reduce interest rates this year, the timing and extent of these cuts remain uncertain and continued high rates could prolong financial strain. The first half of 2024 should tell us a lot about the UK’s prospects of returning to growth over the medium to long term.”