The IMF said on Tuesday that Britain would avoid recession this year, adding that the country’s economy was “encouraged by resilient demand in the context of falling energy prices”.
But the fund cautioned that Britain risks being stuck with persistent inflation as long as interest rates remain high.
“Economic activity has slowed significantly since last year and inflation remains very high,” the fund said in its periodic stocktaking of the UK economy, known as the Article IV report.
It added: “While improving somewhat in recent months, the outlook for growth remains weak.”
The IMF predicted in January that the UK economy would shrink by 0.5 per cent between the last quarter of 2022 and the last quarter of this year. It was still predicting a recession last month.
But, in a significant upgrade on Tuesday, it said the economy is now set to expand 0.4 percent in 2023, reflecting stronger wage growth, more supportive fiscal policy and easing global energy prices and supply chain disruptions.
The fund expects GDP to grow by 1 percent in 2024 and an average of 2 percent in 2025 and 2026.
Survey data released on Tuesday confirmed a picture of consumer-driven growth, with wage growth putting pressure on prices.
S&P Global’s Flash UK Composite Purchasing Managers’ Index fell to 53.9 in May from a high of 54.9 in April. But S&P said it still indicated a “solid expansion”, with demand for travel, leisure and hospitality offsetting weakness in the manufacturing sector.
UK Chancellor Jeremy Hunt said the IMF upgrade reflected the UK government’s “action to restore stability and reduce inflation” and showed that the country’s long-term growth prospects were now “stronger than those of Germany, France and Italy”. .
But the IMF warned that inflation would remain above the Bank of England’s 2 percent target until mid-2025, six months longer than last month’s forecast.
Cautioning against “premature celebration”, the Fund noted the risk that higher energy prices would be replaced by more persistent price and wage pressures that could lead inflation to a higher rate of “plateau”.
The IMF said that if inflation remains high, authorities will need to plan for a sharp decline to bring it under control.
It added, ‘Some more monetary tightening will be needed and rates may have to remain high for a long time.’
The fund urged the Bank of England to focus on underlying measures of inflation such as wage growth and services inflation, rather than the headline rate, which was bound to decline on lower energy prices.
It also warned the UK government to avoid a surge in pre-election spending, which could complicate the BoE’s task of reducing inflation.
“Fiscal policy should stay the course by following the announced consolidation path,” the fund said.
But it argued that in the medium term the UK government needs to overhaul its financial plans to take account of the acute pressure on public services and the investment needed to fuel the country’s long-term growth.
The IMF said that current spending plans include big cuts in some government departments, before factoring in extra money to address challenges in the NHS and social care, invest in the green transition and boost public sector wages.
To accommodate such “critical needs”, it advised that the UK should replace the so-called triple lock which ensures pension payments are in line with inflation, average earnings or 2.5 per cent each year, whichever is higher. .
It also urged the government to strengthen carbon taxation and reform property taxes by moving away from the stamp duty system on house purchases, which it said hindered housing and labor mobility.