The International Monetary Fund has backed the coalition’s deficit reduction plan by concluding that no changes need to be made to the UK’s economic policies at the current time.
In a report on the state of the UK economy, the IMF says the weak growth and rise in inflation seen in recent months were unexpected.
However, it says these deviations from the targets are largely temporary, and therefore there is no need to adjust the government’s macroeconomic policies.
The report says strong fiscal consolidation is underway and continues to be essential to achieving a sustainable budget, while the rise in inflation is driven primarily by transitory factors.
But it says: “Nonetheless, there are significant risks to inflation, growth, and unemployment. If they materialise, the policy response will depend on the nature of the shock.”
The IMF predicts that GDP growth will be moderate in 2011 at 1.5%, before increasing gradually in the medium term to around 2.5%.
It also forecasts that inflation will remain above 4% for the majority of 2011, but will return to near the 2% target around the end of 2012 as transitory factors, such as tax hikes, drop out.
The report says: “Leading inflation indicators support this outlook: growth rates of credit, broad money, and wages are all low, and inflation expectations remain contained.”
The paper adds that if UK economic growth resumes as expected over the new few quarters, then the case for raising the Bank of England base rate would increase.
However, it says rates should only increase gradually, given the extended period of fiscal contraction and the high sensitivity of house prices to short-term interest rates.
The IMF adds, though, that interest rates would need to be raised earlier and faster if leading inflation indicators, such as unit labour costs, become more worrying.