The IMF has asked the Bank of England not to delay raising interest rates as it warns that demand is too strong in the UK economy and inflation will rise to around 5.5% in spring.
In its annual health check of the UK economy, the fund said that “monetary policy needs to withdraw the exceptional support provided for 2020-21”.
Two days ago BoE’s Meeting of the Monetary Policy Committee, they accused the rate-setters of allowing inflationary trends to take root in the UK economy by making excuses to do nothing at their regular meetings.
“It is important to avoid inaction bias, given the costs involved in containing second-round effects [of inflation], said the IMF.
While acknowledging that the BoE’s mandate was a difficult one, at the conclusion of their annual “Article IV” mandate to study the UK economy, IMF staffers hailed the recovery, but said the inflation trend will not disappear quickly.
Inflation is forecast to only return to the BoE’s 2% target in early 2024, after which it has accelerated to “peak around 5.5% in spring 2022”.
The economy should stabilize with output about 2 to 2.5% lower than the path the fund thought was possible before the pandemic, worse than its estimate for other advanced economies.
Inflation would then decline with a combination of lower global energy prices, more efficient supply chains, and tighter control over consumer spending.
This will stem from higher interest rates and less Treasury spending in 2022-23, the IMF said, rather than having most of the post-coronavirus spending restrictions in place next year. It said the change would “help curb demand in the short term with the benefit of also reducing drag on growth.” [the medium term]”.
The Foundation acknowledges that the outlook is highly uncertain with the novel coronavirus variant Omicron spreading rapidly in the UK. It says the new restrictions will slow growth slightly over the winter.
With inflation at the forefront of policy concerns, it focuses on how the central bank should withdraw the support it has provided during the pandemic. This includes lowering interest rates to 0.1% and bringing the total amount generated to buy government bonds to £895 billion.
While the IMF says there is a delicate balance on the timing of monetary tightening needed between weakening confidence and letting inflation become even more persistent, the BoE should recognize that rate hikes are still will leave stimulus measures.
Not saying the BoE should act immediately, but it did tell monetary policymakers not to delay.
“The important thing to keep in mind are the initial steps [to raise interest rates] will still leave policy in place, that changes in policy can provide important signals to lower inflation expectations and that policy is best focused on a period of 12 to 24 months or more. away, when it has maximum impact (and this will be outside of Covid in the short-term -19 developments),” said the IMF report.
