West Midland businesses face a prosperous 2007 even though another interest rate rise is on the cards, according to forecasts from a key economic study today.

The UK economy is looking "very buoyant" and looks to be heading for annual growth of 2.9 per cent next year, the latest report from the Ernst & Young Item Club, which uses the Treasury's own economic model, says.

Item has raised its predicted growth figure from 2.6 per cent and says there is plenty of capacity for growth.

The economy has been bolstered in recent months by a influx of labour from migrant and older workers staying on after retirement, a resurgent stock market, healthy retail sales and rising house prices.

On the down side, a further rise in interest rates is needed to cool the housing market down again.

Item economist Peter Spencer said: "The UK economy is expanding quicker than many of us anticipated – but it can go faster. "However, interest rates need to be raised again in November to stop credit expansion and asset price inflation spilling over into excessive demand and inflation. If house prices continue to accelerate, interest rates will have to rise further in 2007."

The stronger-than-expected growth figures have presented the Chancellor with a tax revenue boom and gives him grounds for confidence when he makes his pre-Budget report. But the tax inflows will have little impact on the Treasury's books in the short term because spending targets have already been overshot, Mr Spencer warned.

"The Treasury may be benefiting from extra tax revenues, but the public purse is still empty," he said.

The Item report was welcomed by Ronnie Bowker, senior partner at Ernst & Young's Birmingham office.

"It supports what I am seeing and hearing across the West Midlands economy," he said. "The region’s economic growth and prosperity has really gathered pace since the beginning of the year, and if the Club’s 2.9 per cent GDP prediction holds firm, then I expect many businesses to have a merry Christmas and prosperous new year.

"The manufacturing sector has continued to improve, experiencing its strongest order book in nearly two years and much of this demand has been driven by an increase in export orders."

Profit warnings from the region's quoted companies fell to just four in the third quarter and retailers are seeing signs of consumers heading for the shops with their Christmas purse strings relaxed. Mr Bowker dismissed the doom and gloom surrounding the West Midland automotive industry.

"Although some commentators paint a bleak picture, figures from our automotive team have revealed that the UK is the third most attractive country for cross-border automotive assembly investment projects in Europe," he said.

"This has had a direct impact on the region’s economy. In terms of attracting new foreign direct investment in the automotive components sector, the region has been the most successful in the UK, with over 80 new projects locating to the West Midlands over the last nine years.

"The outlook for the region’s economy is more positive than it has been for some time, but it is still very sensitive to recent and potential closures in the automotive industry.

"The challenge for the Bank of England is to balance the national picture, where the need to increase interest rates is clearer, with the situation in different regions. If interest rates do rise again in the short term I fear the balance may tip towards negativity here in the Midlands."