The International Monetary Fund has warned that interest rates in the UK will have to stay higher for longer than previously expected to cope with stubbornly high inflation.
The IMF’s regular updates on global economic conditions have singled out the US Federal Reserve and the Bank of England as the two central banks that will need to raise their official borrowing costs more aggressively than was assumed just three months ago.
Growth prospects in the UK are now believed to be brighter than expected in April, but it has taken longer than expected for cost of living pressures to ease. The Washington-based body now assumes that it will take until mid-2025 for inflation to return to the UK government’s 2% target, six months later than previous estimates.
As a result, when the IMF published its forecasts last April, the top projected rate for UK interest rates was now raised to between 5% and 5.5%, up from 4.5%, and Threadneedle Street will likely have to maintain its tightening policy through the end of 2024.
The UK, which has been the fastest growing of the G7 economies in 2021 and 2022, is projected to be the second laggard this year, despite improving performance since April. Only Germany, which is expected to decline by 0.3%, is expected to grow more slowly.
UK interest rates are at 5% after 13 consecutive hikes since December 2021. The Bank’s Monetary Policy Committee meets next week and financial markets expect the next move to be 0.25 points to 5.25%.
The IMF publishes its overall world economic outlook twice a year, in April and October, but updates are provided in July and January. According to the latest report, the UK will grow by 0.4% in 2023. This is an upgrade of 0.7 percentage points from forecasts three months ago, but unchanged from forecasts included in our annual in-depth study of the UK published in May.
The largest upward revision among G7 countries since April reflected stronger-than-expected consumption and investment driven by the confidence effect of lower energy prices, reduced post-Brexit uncertainty following the EU’s Windsor Framework Agreement on trade in Northern Ireland in February, and a resilient financial sector as global banking stress eased in March, he said.
For the global economy as a whole, the fund raised its 2023 growth forecast to 3% from 2.8% three months ago, and did not change its 2024 growth forecast to 3%.
The 2023 outlook is slightly higher than predicted in the April 2023 World Economic Outlook, but remains weak by historical standards, the update said. The global recovery from the COVID-19 pandemic and the Russian invasion of Ukraine is slowing amid widening economic sectors and regional disparities.
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“The central bank’s interest rate hikes to curb inflation continue to put pressure on economic activity,” he added. Global headline inflation is expected to fall from 8.7% in 2022 to 6.8% in 2023 and 5.2% in 2024. Underlying (core) inflation is expected to decline more gradually, and inflation projections for 2024 have been revised up.
The IMF said the priority for most countries is to achieve sustained disinflation, while acknowledging that central banks may risk overtightening and triggering a recession. It urged the central bank to remain focused on restoring price stability and strengthening financial supervision and risk monitoring.
Core inflation, a measure of the cost of living excluding items such as energy and food, remained high, well above the target set by the central bank.
The IMF said wage-price growth and wages accelerating together over a sustained period of time appear to be out of place in the average developed economy. In response to the continuation of core inflation, major central banks have communicated the need for further tightening of monetary policy, he added.
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