The International Monetary Fund’s Article IV staff report is largely upbeat on the UK’s economic recovery, but says sterling is overvalued and warns that the Bank of England Monetary Policy Committee may have to tighten policy quickly.
The MPC has said, in the second phase of forward guidance, it expects Bank Rate increases to be “limited and gradual” but the IMF warns that events could overtake policymakers.
The IMF says that while the current ultra accommodative policy is appropriate for now “Policy might, however, have to be tightened quickly if costs run ahead of productivity growth or slack is absorbed,” the report says.
Productivity growth has been exceptionally weak in the UK, but policymakers believe that rising business investment should help to correct this.
“We don’t see a rate increase being imminent,” the IMF Mission Chief to the UK, Philip Gerson, said in a conference call with reporters.
Analysts and market participants are divided over whether the first hike in Bank Rate is most likely to come in November this year or February next year, both Quarterly Inflation Report months.
The MPC has been offering no clear guidance on the most likely date of the first hike and the IMF gives its backing to this cloudy approach.
The BOE “should continue to point to a forthcoming normalization of monetary policy, while avoiding spurious precision about either the timing or the size of the move,” the IMF says.
The IMF identifies a risk that borrowers and lenders’ decision making could be swayed by the perception monetary conditions will remain accommodative.
This poses a tricky balancing act for the MPC of “reducing the risk of potential market surprises, yet without imparting a false sense of certainty about the evolution of interest rates,” the IMF says.
The IMF’s UK growth forecasts are for 3.2% growth this year and 2.7% next.
Strong growth is leading to shrinking economic slack, but the IMF sees slack only narrowing to 1.3% of GDP this year, still within the BOE’s central estimate of 1 to 1.5% contained in the May QIR.
The supranational body predicts the jobless rate will only hit its 5.5% natural rate, which is a natural rate forecast below the BOE’s current one, by 2019.
Theory, however, dictates policy should be tightened before the natural, or non-inflationary, rate is hit as policy acts with lags but the IMF forecasts suggest no immediate pressure on the central bank to tighten.
The UK’s current account deficit has widened markedly, standing at 4% of GDP last year, due to a sharp deterioration in the income balance and weak export growth.
The IMF says the UK’s net external position is not a concern at present but warns against complacency and says the current account balance is 2.6% wider than its equilibrium level.
In light of this “the real exchange rate is overvalued by 5-10%,” it concludes.