United Kingdom: IMF Executive Board Concludes 2023 Article IV Consultation

July 11, 2023

Washington, DC: The Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation [1] with the United Kingdom.

The post-pandemic recovery was disrupted by the sharp energy price shock due to Russia’s war in Ukraine; labor force participation has declined, mainly on account of rising long-term illness; and large policy rate increases—needed to arrest high and sticky inflation—have tightened financial conditions. Market stress following the September 2022 ‘mini-budget’ has dissipated in the context of a successful financial stability intervention by the Bank of England and two prudent budgets. Post-Brexit uncertainty has declined thanks to the Windsor Framework.

The outlook for growth remains subdued. Staff forecasts growth to slow to 0.4 percent in 2023, held back by tighter monetary and fiscal policies needed to curb inflation, and lingering impacts of the terms-of-trade shock. Growth is projected to rise gradually to 1 percent in 2024, as disinflation softens the hit to real incomes, and to average around 2 percent in 2025 and 2026, mainly on the back of a projected easing in monetary and financial conditions. Thereafter, growth is projected to settle at the trend growth of 1½ percent. Declining energy prices and widening economic slack are expected to substantially reduce inflation to around 5¼ percent by end-2023; and below the 2 percent target by mid-2025.

Risks are considerable in the period ahead. The major near- to medium-term risk is greater-than-anticipated persistence in price- and wage-settings, leading to higher inflation for longer. Should such upside risks to inflation materialize, headwinds to growth would likely be intensified by tighter demand-management policies needed to combat inflation; and/or a drift-up in inflation expectations, which could lead to a re-pricing of long-term financial assets, with adverse macro-financial spillovers. Downside risks also include a further tightening in global financial conditions that restrains credit and trading partner demand. The impact on growth would be amplified if there is contagion to the UK financial sector and/or if adverse macro-financial feedback loops, such as a housing market correction, are triggered.

Executive Board Assessment [2]

Directors noted that the post‑pandemic recovery was held back by the energy price shock, labor supply constraints, and tightening financial conditions. They commended the authorities on their decisive response to the September 2022 liability‑driven investment (LDI) crisis and for their management of the fallout from the recent global banking stress. While the United Kingdom is expected to avoid a recession in 2023, Directors noted the high uncertainty associated with the economic outlook and agreed that risks are tilted to the downside for growth and that high and persistent inflation remains the key near‑term policy challenge.

Directors welcomed the Bank of England’s (BoE) policy response to arrest inflation pressures, including the 50 bps policy rate increase on June 22. Given risks and uncertainty about the outlook and inflation persistence, Directors concurred that a continuous review of the pace and magnitude of monetary tightening is warranted. Should inflationary pressures show signs of further persistence, the policy rate may have to be raised further and would need to remain higher for longer to durably lower inflation and keep inflation expectations anchored . Directors supported the BoE’s incremental approach to reducing its balance sheet via quantitative tightening. They underscored the importance of clear communication of monetary policy decisions, including in situations where markets perceive tensions between price and financial stability objectives.

Directors concurred that fiscal policy should support monetary policy in the fight against inflation. They welcomed the authorities’ fiscal consolidation plan, which will help to rebuild fiscal buffers, and encouraged the authorities to save any near‑term fiscal overperformance. Directors noted that preserving high‑quality public services and undertaking critical public investments will imply increased spending needs over the medium term. Accommodating these needs while stabilizing the debt path will require additional high‑quality revenue measures—such as strengthening carbon and property taxes and eliminating loopholes in wealth and income taxation—and reforming pensions . Directors encouraged the authorities to consider further strengthening the fiscal framework.

Directors noted that the financial system has shown resilience to shocks, and emphasized the need for continued vigilance of financial stability risks, including in the mortgage and real estate markets. They encouraged continued close monitoring of liquidity positions of all banks, and an in‑depth study of depositor behavior to support policy work on the liquidity coverage ratio. Directors also supported ongoing efforts to better understand and reduce non‑bank financial institutions’ (NBFIs) vulnerabilities, including through a system‑wide exploratory scenario, and closing of NBFI data gaps in collaboration with other jurisdictions. They noted the authorities’ ongoing consideration of options to improve depositor outcomes in resolution and recommended that ongoing financial regulatory reforms preserve the primacy of financial stability. Enhancing the effectiveness of the AML/CFT supervisory regime remains important.

Directors emphasized the importance of structural reforms to strengthen the labor supply, boost business investment, and enhance productivity, and welcomed the authorities’ initiatives in this regard, including the Chancellor’s 4Es strategy for Enterprise, Education, Employment and Everywhere, the Spring Budget, and the Windsor Framework agreement with the EU. They underscored, however, the need for further measures, including to improve health outcomes, fine‑tune immigration arrangements to address labor and skills shortages and enhance labor market flexibility, increase critical public investment, provide permanent incentives for investment, and ease planning restrictions. Investing in education and skills and R&D support would also enhance productivity. Directors welcomed the United Kingdom’s leadership in decarbonization and their ambitious Net Zero climate agenda. They encouraged the authorities to accelerate the green transition in support of their climate targets and to enhance energy security.