IMF Says U.K. Shows The Wrong Way To Fight Inflation Crisis
Speaking to the media, Gourinchas urged the chancellor to use his Oct. 31 fiscal update to change course.
(Bloomberg) --
The International Monetary Fund has signaled that the UK government will need to work more closely with the Bank of England if it is to tackle the cost of living crisis successfully.
At its annual meetings in Washington, the Fund indicated that Chancellor Kwasi Kwarteng needs to unveil plans for savings in the coming weeks to ensure his “fiscal package is going to be consistent with what the Bank of England is trying to do.”
Pierre-Olivier Gourinchas, the IMF’s economic counselor, compared the current to “two people trying to hold the steering wheel” and turn the car in different directions. “It’s not going to work very well,” he said.
The comments follow its attack last month on the chancellor’s mini-budget, at which he pledged £45 billion of unfunded tax cuts that sparked a run on the pound and drove up market interest rates amid fears that borrowing and prices would spiral upwards.
Kwarteng has scrapped £2 billion of tax cuts and brought forward plans to grapple with the debt at a fully costed fiscal event at the end of the month, which will be audited by the independent Office for Budget Responsibility. The IMF has welcomed those moves.
“Fiscal policy should not work at cross-purpose with monetary authorities’ efforts to bring down inflation,” Gourinchas wrote in a blog, not naming the UK specifically but repeating the language from its criticism last month. “Doing so will only prolong inflation and could cause serious financial instability, as recent events illustrated.”
Speaking to the media, Gourinchas urged the chancellor to use his Oct. 31 fiscal update to change course and withdraw or offset some of the stimulus unveiled last month. Aligning fiscal policy with the central bank by removing demand would help stabilize U.K. markets, he added.
“It’s very clear that stability can be improved in financial markets and more broadly with a fiscal package that is going to be consistent with that,” he said.
The IMF figures show UK inflation will be more persistent than in other Group of Seven industrial nations, still at 6.3% at the end of next year. The Institute for Fiscal Studies has separately estimated that the UK will need to find £60 billion of savings to bring debt down as a share of GDP in the fiscal year ending in 2027, about twice as much as the annual defense budget.
The IMF also questioned Truss’s growth plan and energy support package, which will stimulate the economy at a time when the BOE is fighting inflation.
Kwarteng is cutting taxes and deregulating to unleash growth, but Gourinchas suggested using the money for investment would be a better approach.
“Fiscal policy can help economies adapt to a more volatile environment by investing in productive capacity: human capital, digitalization, green energy, and supply chain diversification,” he said. “Expanding these can make economies more resilient to future crises. Unfortunately, these important principles are not always guiding policy right now.”
Kwarteng has already abandoned a plan to cut taxes for the highest earners, saving £2 billion.
On the energy program, which will cost £60 billion over six months, he added: “The package, aimed at assisting all families and businesses dealing with high energy prices, has scope for better targeting the vulnerable, which would lower the cost and preserve incentives to save energy.”
The implied and direct critiques overshadowed its relatively strong forecasts for the UK. Britain will grow fastest of all G-7 economies this year, at 3.6%. However, official UK data shows that it remains the only G-7 nation not to have recovered to pre-pandemic levels of GDP.
Next year, the UK will grow 0.3%, faster than both Germany and Italy in the G-7, both of which will be in recession, according to the IMF outlook.
The forecasts were drawn up before Kwarteng’s mini-budget and his package of measures “is expected to lift growth somewhat above the forecast in the near term, while complicating the fight against inflation,” the IMF said.
Before Kwarteng’s tax giveaway, the outlook for UK national debt was also better than most G-7 peers. The IMF has UK gross debt at just 68% of GDP in 2027, close to Germany at 60%, and at least 20 percentage points lower than any other G-7 nation.
(Updates with more comment from Gourinchas)
More stories like this are available on bloomberg.com
©2022 Bloomberg L.P.