The Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with United Kingdom.
The UK economy entered 2020 with some challenges but also with some strengths. Key challenges included agreeing to a post-Brexit trade deal with the EU, weak productivity growth, large regional disparities in income, population aging (and its impact on pension spending), and the need to strengthen climate policies.
At the same time, the economy was operating at full employment, inflation was close to target, household and corporate debt burdens had fallen substantially since 2009, the banking system was well-capitalized and liquid, and fiscal adjustment had set debt on a declining trajectory, with fiscal space available.
The pandemic has taken a significant human and economic toll, mitigated somewhat by an aggressive policy response. An even more tragic health impact was averted by a spring lockdown, subsequent restrictions, and a second lockdown announced in early November.
These health restrictions hit economic activity hard, with a sharp decline in GDP in Q2. Nonetheless, a coordinated fiscal, monetary, and financial sector policy response has helped to hold down unemployment and insolvencies.
Despite a rebound as the economy re-opened in the summer, growth for 2020 will likely be around -11 percent, with core inflation below target, and the current account deficit subdued at about 2½ percent.
The outlook is challenging. The second lockdown has already dampened activity. Prolonged social distancing in its aftermath and frictions associated with implementation of the new Brexit trade regime are expected to generate strong headwinds through mid-2021 (and for even longer if a free trade agreement cannot be reached).
Still, as full re-opening occurs helped by vaccines, GDP is projected to rebound and grow by 5.7 percent in 2021 and about 4.5 percent in 2022. A faster recovery would be held back by corporate and household stress as exceptional fiscal support abates and the economy adjusts structurally to the new landscape once the immediate impact of Covid and Brexit recedes.
By 2025, the level of output is projected to recover to about 5 percent below the pre-Covid trend, reflecting weaker investment and higher unemployment in the interim. Risks to the outlook are to the downside, centering on the pace at which the impact of the pandemic fades and the degree of balance sheet damage sustained by households and small and medium enterprises. Faster vaccine deployment could mitigate risks.
Executive Board Assessment
Directors noted that the pandemic has taken a significant human and economic toll in the U.K. economy already facing strains from Brexit and long-term challenges. They commended the authorities’ strong and coordinated policy response, which has helped mitigate the damage.
With uncertainties remaining high, Directors stressed that policy support will remain essential to see the economy through the pandemic and the transition to the post-Brexit trade regime.
Directors stressed that fiscal policy should continue to fully fund targeted pandemic support programs. They underscored the need to be prepared to respond in case further downside risks materialize and welcomed the authorities’ flexibility in this regard.
As the pandemic subsides, targeted fiscal support using available space could help invigorate growth. Directors welcomed the authorities’ plans to expand public investment and recommended assessing the adequacy of the public investment management framework.
Directors emphasized that a gradual fiscal consolidation, necessary to contain the debt burden over the medium term, should only start once the private sector is durably leading the recovery. They saw merit in a full expenditure review to prepare for consolidation.
A number of Directors also suggested being open to consider some adjustment to major tax rates and exploring fiscal measures in support of the climate agenda. In this context, Directors took positive note of the U.K.’s ambitious climate plans.
Directors considered that monetary policy should remain accommodative and welcomed the Bank of England’s commitment to increase government bond purchases. They generally noted that a negative policy rate could be part of the toolkit but recommended further study on how best to deploy it.
Directors stressed the role of the financial system in funding the recovery. While recognizing banks’ sizable buffers, they cautioned that uncertainty related to SME stress and commercial property prices calls for continued close supervision.
Directors underscored that adjustment to the pandemic and Brexit will require some reallocation of labor and capital. They saw room to further strengthen the social safety net, enhance active labor market policies, streamline insolvency procedures, and unlock equity finance.
Directors commended the enviable track record of the U.K.’s policy frameworks. They suggested considering updates to the fiscal framework where needed once uncertainty abates. Whether the monetary framework may need adjustment to address the risk of persistent low inflation also merits consideration. The 2021 FSAP will also be an opportunity to consider emerging financial sector challenges.
Directors emphasized that agreement on a new post-Brexit trade regime would benefit both the U.K. and the EU and reduce outward spillovers. They welcomed steps taken to eliminate systemic financial sector risks and urged the U.K. authorities to complete trade infrastructure preparations.
Contingency plans will be needed in case no agreement is reached. In such a scenario, it will be important to keep expectations anchored and pursue stronger policy support.
Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country’s economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board.
At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country’s authorities.