UK interest rates need to stay higher for longer to beat inflation, says IMF

Interest rates in the UK will need to stay higher for longer than previously forecast in order to tackle stubbornly high inflation, the International Monetary Fund has warned.

The IMF’s regular update on the state of the global economy singled out the US Federal Reserve and the Bank of England as two central banks that will need to raise official borrowing costs more aggressively than it assumed only three months ago.

While the UK’s growth prospects are now thought to be brighter than predicted in April, it has taken longer than expected for cost of living pressures to ease. The Washington-based body now assumes it will take until the middle of 2025 for inflation to return to the British government’s 2% target – six months later than its previous estimate.

As a result, the expected peak in UK interest rates – put at 4.5% when the IMF last published forecasts in April – has now been raised to 5-5.5% and it thinks Threadneedle Street will need to keep policy tight until the end of 2024.

After being the fastest growing of the G7 economies in 2021 and 2022, the UK is expected to be the second most sluggish economy this year, despite an upgrade on its performance since April. Only Germany, which is forecast to contract by 0.3%, is predicted to grow more slowly.

Interest rates in the UK stand at 5% after 13 successive increases since December 2021. The Bank’s monetary policy committee meets next week, with the financial markets on balance expecting the next move to be a 0.25-point rise to 5.25%.

The IMF produces its full world economic outlook twice a year – in April and October – but provides updates in July and January. Its latest report says the UK will grow by 0.4% in 2023 – a 0.7 percentage point upgrade on its forecast three months ago but unchanged on the forecast contained in its annual in-depth study of the UK alone published in May.

It said the upward revision since April – the biggest of any G7 country – reflected “stronger-than-expected consumption and investment from the confidence effects of falling energy prices”, lower post-Brexit uncertainty after the Windsor framework agreement struck with the EU in February over Northern Ireland trade, and “a resilient financial sector as the March global banking stress dissipates”.

For the global economy as a whole, the fund has revised up its growth forecast for 2023 from 2.8% three months ago to 3% and has left its 3% growth forecast for 2024 unchanged.

“While the forecast for 2023 is modestly higher than predicted in the April 2023 world economic outlook, it remains weak by historical standards,” the update said. “The global recovery from the Covid-19 pandemic and Russia’s invasion of Ukraine is slowing amid widening divergences among economic sectors and regions.”

It added: “The rise in central bank policy rates to fight inflation continues to weigh on economic activity. 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 projected to decline more gradually, and forecasts for inflation in 2024 have been revised upward.”

While accepting there is a risk of central banks tightening too much and triggering recessions, the IMF said the priority in most countries was to achieve sustained disinflation. It urged central banks to remain focused on restoring price stability and strengthening financial supervision and risk monitoring.

Core inflation – a measure of the cost of living that strips out items such as energy and food – remained high and well above the targets set by central banks.

Wage-price spirals – prices and wages accelerating together for a sustained period – did not appear to have taken hold in the average advanced economy, the IMF said. “In response to the persistence of core inflation, major central banks have communicated that they will need to tighten monetary policy further,” it added.

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