The IMF has urged the Bank of England to raise interest rates, warning that demand was too strong in the economy and UK inflation would rise to about 5.5 per cent early next year.
Two days ahead of the central bank’s next Monetary Policy Committee meeting, Kristalina Georgieva, the IMF’s managing director, said the UK’s monetary policy needed to “withdraw the exceptional support provided during 2020”.
In its annual health check on the British economy, the fund accused the BoE’s interest rate setters of allowing inflation to spiral in the UK economy by finding excuses to do nothing at its regular meetings. “It would be important to avoid inaction bias, in view of costs associated with containing second-round impacts [of inflation],” the IMF said.
While acknowledging that timing monetary tightening was difficult, the IMF staff praised the recovery from the pandemic but said inflationary tendencies would not fade quickly.
It forecast that inflation would only return to the BoE’s 2 per cent target by early 2024, having risen to “peak at about 5.5 per cent in the spring of 2022”.
The economy would settle with output around 2 to 2.5 per cent below the path the fund thought possible before the pandemic, worse than its estimates for other advanced economies, something Georgieva said was due to job market tightness limiting the amount the economy could grow without inflation.
“We are in no position today yet to identify to what extent [this labour market tightness] is due to the pandemic and what role Brexit may play in it,” she said.
Inflation would come down after that with a combination of lower global energy prices, more effective supply chains and tighter control of consumer spending power.
This should come from higher interest rates, the IMF said, and the Treasury spending less in 2022-23 rather than having most of the post-coronavirus spending restraint in the following year. It said this shift would “help contain demand in the short run with the benefit of also reducing the drag on growth in [the medium term]”.
The fund acknowledged that the outlook was highly uncertain with the new Omicron coronavirus variant spreading rapidly in the UK. It said that new restrictions would lower growth a little over the winter.
With inflation its top policy concern, it focused on how the central bank should withdraw the support it had provided during the pandemic. This included lowering interest rates to 0.1 per cent and raising the total amount of money created to buy government bonds to £895bn.
While the IMF said there was a delicate balance in the timing of the necessary monetary tightening between undermining confidence and allowing inflation to become even more persistent, the BoE should recognise that raising rates would still leave stimulus in place.
Without saying the BoE should act immediately, it told monetary policymakers not to delay. “It is important to bear in mind that initial steps [to raise interest rates] would still leave policy accommodative, that changes in policy can provide important signals to dampen inflation expectations, and that policy is best focused on the period 12 to 24 months out, when it has its maximum impact (and this would be beyond near-term Covid-19 developments),” the IMF report said.
The BoE declined to comment on the IMF report.
Source: Economy - ft.com
