IMF: UK's economic outlook remains robust but inflation and Ukraine tensions pose a risk

Britain expects growth of 4.7% in 2022 with inflation peaking at 7% in the spring

Commuters outside London Bridge railway and Underground station. The government has said it intends to lift all remaining Covid restrictions in England - including the rule to self-isolate - this month. PA

Britain’s short-term economic growth outlook remains strong, but it faces inflation pressures, the threat of escalating tensions in Eastern Europe and new coronavirus waves, the International Monetary Fund said on Wednesday, as it commended the government for its handling of the pandemic last year.

Despite an expected slowdown in the first quarter of this year because of the Omicron variant and the restrictions to tackle it, the UK economy is expected to grow by 4.7 per cent in 2022, with inflation peaking at 7 per cent in the spring, according to the IMF’s 2021 Article IV Consultation.

Inflation is then expected to return to the Bank of England’s target level of 2 per cent by the second quarter of 2024, boosted by declining global energy prices, more robust supply chains, and tighter demand management policies.

“Risks are considerable in the period ahead. There is a risk of higher inflation in the near term, but two to three years out, the risk shifts to lower growth – as policy interventions pull inflation back,” the IMF said.

“However, the major risk stems from new Covid-19 waves and spillovers from tensions in Eastern Europe.”

In the medium-term, growth is projected to ease to about 1.5 per cent, the IMF said, with real GDP settling about 2 to 2.5 per cent below its pre-pandemic trend, held back by investment shortfalls in 2020–2021 and a less-than-full recovery of labour force participation.

Britain’s economy was ravaged by the fallout from the pandemic in 2020, with output contracting 9.4 per cent in 2020 – the biggest drop since 1919 when there was demobilisation after the First World War.

However, the UK enjoyed a stronger recovery than its peers in the G7 in 2021, rebounding 7.5 per cent in 2021, according to the Office for National Statistics, its strongest year of growth since the Second World War, after pandemic restrictions were eased across the country.

The surge in output was bolstered by billions of pounds of government aid to support jobs and businesses through the crisis. Its economy managed to grow by 1 per cent in the last three months of the year when Omicron struck.

The recovery in 2021 has proceeded faster than expected, the IMF said. Its directors attributed that to the government’s strong policy measures and rapid vaccination campaign that helped contain the health, economic, and financial impact of the pandemic.

As a result, the IMF estimates growth will reach 7.2 per cent in 2021 thanks to the “continued policy support and rapid vaccination”.

However, it raised the alarm over inflation rising to 5.4 per cent in December amid “strained global supply chains, rising traded goods and energy prices, and tightened labour markets”.

The IMF welcomed the Bank of England’s recent policy rate increases and the move to withdraw the exceptional monetary support provided during 2020–2021 to counter growing inflation pressures.

While the Washington-based lender supported gradual fiscal tightening and said policies should retain an important role in responding to large macroeconomic shocks, it said well targeted support is needed to protect households from the sharply rising cost of living.

Britain’s cost-of-living crisis is now being felt by three out of four adults, according to the ONS, as the country braces for a further squeeze in April when higher energy bills and taxation take effect.

While the near-term outlook remains strong, the IMF stressed that it is subject to significant risks, including emerging price pressures, medium-term scarring and coronavirus uncertainties.

The UK's Build Back Better: Our Plan for Growth agenda as it seeks structural transformation for green, inclusive growth, was also praised by the IMF, which welcomed the country’s “ambitious” Net Zero Strategy and encouraged the authorities to hone it as necessary to reach their targets.

The UK’s “well-functioning financial stability framework with resilient banks and insurers” was also commended for helping to support the safety and soundness of the core part of the UK financial system through the strains of Brexit and the Covid-19 shock.

However, data and information gaps exist concerning non-bank financial institutions and their cross-border operations, the IMF said, with debtors, creditors, and market intermediaries facing interlinked risks from adverse macrofinancial effects of a prolonged pandemic, lingering post-Brexit uncertainties on financial services, to rapidly shifting financial conditions.

Britain will unlock "tens of billions of pounds" of insurance sector capital that should boost the economy through infrastructure investment, financial services minister John Glen said on Monday.

The six-year-old Solvency II capital requirements were inherited from the European Union when Britain left the bloc's orbit at the end of 2020.

The long-flagged reform is seen by insurers and Brexit supporters as an early test of how Britain can exploit its freedom to write its own financial regulations, and the government is keen to show tangible benefits from leaving the EU.

“Post-Brexit regulatory and related institutional reforms that are now being considered offer the opportunity to reaffirm the primacy of the authorities' objective of financial stability,” the IMF said.

Updated: February 23, 2022, 11:22 AM
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