December 14, 2021
Ladies, Gentlemen:
Earlier today I had a very good discussion with Chancellor Sunak and Governor Bailey on our assessment about the economic outlook for the United Kingdom and this time we also evaluated UK’s financial stability conditions under the FSAP, which was last done in 2016.
Let me start by saying, that while it was a difficult year for the UK with the pandemic and post-Brexit adjustments, the economy proved to be more resilient than expected. And the foundation for this resilience came from a rapid vaccination campaign, and strong coordinated policy support, on the basis of which output and employment have returned close to pre-pandemic levels even with the headwinds that the UK and the world is facing. Financial stability has been preserved. The UK’s strong policy frameworks have been critical to providing the space to facilitate the impressive and coordinated policy response.
That said, Covid-19 and the changes it has caused will not fade quickly. These changes have strained supply chains, contributed to rising prices, and tightened labor markets, putting pressure on inflation, both globally and in the UK. And now a new variant of Covid has which once again raises uncertainty and complicates policymaking.
For the outlook, we still see strong growth in the near-term—about 6.8 percent in 2021 and 5 percent in 2022 consistent with our October WEO projections—but Omicron will have some impact in the near term, and inflation pressures will linger into 2022, estimated to peak at about 5½ percent. Risks are considerable in the period ahead and Omicron also brings considerable uncertainty.
To summarize our advice, I will go into four areas:
First, near-term macroeconomic management
Monetary policy needs to withdraw the exceptional support provided during 2020. When determining the pace of withdrawal policymakers will have to weigh the risks to inflation and growth.
Fiscal policy should retain an important role in responding to large shocks. We saw its efficacy during the pandemic, and in the event of new widespread mandated closures for health reasons, there is now a playbook to be reused. It could also have a role in responding to present supply-demand imbalances.
Macroprudential polices will need to maintain strong vigilance in a period where real interest rates are low and risk taking high.
Second, managing policies in a context of higher volatility
The macroeconomic landscape is likely to be more volatile going forward. Let me just highlight that fiscal policy has a key role to play in addressing volatility through automatic stabilizers. These are already high in the UK, but pandemic support policies in the skills-building and small business areas should be evaluated as options for more of a more permanent status.
Third, anchoring policies and preserving space through strong frameworks
Here, I want to highlight that our FSAP found that the financial soundness of UK banks and insurers has increased since the global financial crisis. The system is better placed today that at the time of the 2016 FSAP to face near-term macrofinancial challenges.
However, the UK financial system is undergoing several important structural transitions. The FSAP took a deeper dive into these areas, including on climate-related financial risks and disclosures.
The FSAP suggests that some policy enhancements. These could help manage risks better, including the continued expansion of the scope and perimeter of systemic risk monitoring and analysis, and addressing the data gaps for effective oversight of cross border nonbank (NBFI) risks.
Finally, and importantly, Building Back Better
The authorities have put forward and funded a comprehensive growth strategy. We welcome the growth pillars covering infrastructure, skills, and innovation; and strategies, for instance Leveling Up and Net Zero. However, options to scale up efforts further should be pursued, supported by raising additional revenues.
I want to highlight that the Net Zero Strategy is a major achievement. More steps lie ahead, and we would encourage the authorities to deliver at the ambitious end of the spectrum.
Let me conclude by saying that despite the renewed surge in Covid-19 cases, the UK has advanced in many respects versus this time last year. Highlights include a successful vaccination campaign—now focused on booster shots–the Trade and Cooperation agreement reached with the EU, and a much stronger economy and labor market than expected. I believe that with continued collaboration and strong solidarity, the United Kingdom can build forward better, creating an economy that is more resilient, sustainable, and inclusive.
Thank you.