Things are looking good for the UK economy in the coming year, with strong growth and robust business saving and investment driven by the booming financial services sector, according to a report.

The Ernst & Young ITEM Club, using the Treasury’s model of the economy, predicted growth of 2.9% in 2007, although it did warn that inflation needed to be contained if further interest rate rises were to be avoided.

The report warned that the Bank of England would not hesitate to raise rates again if there were signs that inflation was pushing up salaries.

Peter Spencer, ITEM’s chief economic adviser, said: “The recent hike in interest rates was a warning shot to wage negotiators that the 2% inflation target, as a saving and investment yardstick, is non-negotiable.

“Settlements must be based on the target, not the inflation headlines.”

Average earnings increased by 4.1% in the year to November, while target inflation – or the Consumer Prices Index – also rose to 3% and the Retail Price Index jumped to 4.4%.

However, the ITEM Club forecast that astute saving and investment tactics would see inflation back down to the target rate of 2% this year, caused by falling energy prices and more people taking up full-time employment.