IMF Executive Board Concludes 2016 Article IV Consultation with the United Kingdom
The UK economy has performed relatively well in recent years, with economic growth consistently near the top among major advanced economies and the employment rate at a record high. However, growth has slowed somewhat in the first part of 2016, as heightened uncertainty ahead of the referendum on EU membership appears to be weighing on investment and hiring decisions.
In a baseline scenario in which the UK remains in the EU, growth is expected to recover in late 2016, as referendum-related effects wane, and to average around 2.2 percent over the medium term. Inflation is expected to rise gradually from its current low level (0.3 percent as of May 2016), as disinflationary effects from past commodity price falls dissipate and as tighter labor markets and minimum wage hikes help push up wages.
However, this broadly positive baseline scenario is subject to risks, including those related to the referendum; the current account deficit, which reached a record high in 2015; uncertainty about the degree to which productivity growth, which has been low since the crisis, will recover; and vulnerabilities associated with property markets, which have been buoyant in recent years.
Economic policy has aimed to increase resilience while maintaining steady and sustainable growth. The overall fiscal deficit has been cut to about 4 percent of GDP in FY15/16, down from a peak of over 10 percent of GDP in FY09/10. Monetary policy has stayed accommodative, with the policy rate unchanged at 0.5 percent, given subdued inflationary pressures and helping to support growth. Structural reforms have aimed to boost potential output by, for example, efforts to ease regulatory impediments to housing construction.
Major financial sector reforms have been adopted since the crisis, helping to bolster resilience and requiring banks to increase buffers in their balance sheets. This progress was assessed in detail during this Article IV consultation as part of the IMF’s Financial Sector Assessment Program (FSAP), which analyzes financial sector health and associated policies. The FSAP’s findings are summarized in the accompanying Financial System Stability Assessment (FSSA).
Executive Board Assessment2
Executive Directors welcomed the United Kingdom’s strong economic performance in recent years and the progress made in the post-crisis repair of the economy. They expected steady growth to continue under staff’s baseline scenario in which the United Kingdom remains in the EU. At the same time, Directors noted that this relatively positive outlook is subject to risks and uncertainties, including those related to the global environment, low productivity growth, a weak external position, and still-high levels of household debt. They encouraged the authorities to remain vigilant to the challenges ahead and to continue their policy efforts to promote growth and further boost resilience.
Directors viewed the upcoming EU membership referendum as the main near-term economic uncertainty. While recognizing that this choice is for U.K. voters to make and that their decisions will reflect both economic and noneconomic factors, Directors agreed that the net economic effects of leaving the EU would likely be negative and substantial. In the event of a vote to leave, Directors recommended that policies be geared toward supporting stability and reducing uncertainty. In the event of a vote to remain in the EU, Directors concurred that macroeconomic policies should focus on promoting steady growth and continuing to reduce vulnerabilities.
While recognizing the substantial fiscal consolidation efforts made to date, Directors supported the authorities’ plans to further bolster the public finances and rebuild buffers through gradual deficit reduction. They also supported maintaining an accommodative monetary policy until inflationary pressures become clearer, although vigilance to financial stability risks should be maintained. Directors agreed that a policy mix of tight fiscal and accommodative monetary policies should assist external rebalancing.
Directors emphasized that policies will also need to respond flexibly to shocks. In the event of protracted demand weakness and inflation undershooting, monetary and fiscal policies should be eased, taking into account the benefits and potential costs of such a move. Conversely, monetary tightening may need to be initiated earlier than currently envisaged if core inflation or wage growth in excess of productivity growth begins to rise sharply. Directors stressed that careful communication of policy changes will be particularly important in this environment.
Directors welcomed the notable improvement in financial sector soundness since the crisis, owing in large part to post-crisis regulatory reform. A robust and intrusive approach to prudential supervision and regulation will be essential as the financial cycle matures. Directors concurred with the findings and recommendations of the Financial System Stability Assessment, including the need to further strengthen analysis on interconnectedness, ensure close scrutiny of banks’ internal models, and complete the resolution reform agenda. Directors also welcomed the authorities’ efforts to deepen their understanding of the “de-risking” phenomenon and encouraged them to develop tailored responses.
Directors noted that macroprudential policy will need to remain alert to emerging risks. In particular, mortgage-related macroprudential policies would need to be tightened later this year if housing and mortgage markets remain buoyant, with similar types of limits applied also to the buy-to-let market. The authorities should actively use the countercyclical capital buffer, which may need to be increased later this year. Directors noted that ensuring that macroprudential policies are sufficiently tight would also support private-sector saving.
Directors agreed that structural reforms should continue to complement macroeconomic policy to help sustain growth, raise productivity, and strengthen external sector performance. Priorities include continued efforts to boost housing supply, increase investment in infrastructure and human capital, enhance labor force participation, reduce distortionary tax expenditures and the debt bias in the tax code, and reform pensions. Directors also encouraged the authorities to build on recent reforms to further enhance corporate transparency, including in UK overseas financial centers, and combat financial crimes.