IMF urges Bank of England to stay flexible on rates as U.K. inflation risks rise

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IMF urges BOE flexibility on rates

Highlights

IMF upgrades 2024 U.K. growth forecast to 1% from 0.8% and urges Bank of England to retain flexibility on interest rate direction.
IMF states keeping Bank Rate at 3.75% for the rest of the year is sufficiently restrictive to contain inflation despite higher energy prices.
IMF expects U.K. inflation to briefly rise, delaying 2% target return by about a year, but forecasts target achievement by end of 2027 under current outlook.

IMF outlook reshapes rate expectations

As reported by CNBC, the International Monetary Fund on Monday upgrades its forecast for U.K. economic growth this year to 1% from 0.8% and says the Bank of England should preserve flexibility to move interest rates in either direction.

The fund says monetary policy should remain restrictive so that higher energy prices do not feed into core inflation and wage growth. It adds that the recent rise in energy costs lifts headline inflation this year while also weighing on output, making policy decisions harder to calibrate.

The IMF says keeping the Bank Rate at 3.75% for the rest of the year would maintain a sufficiently restrictive stance to limit second-round effects and keep longer-term inflation expectations anchored. At the same time, it says the central bank should be prepared to cut rates if needed to support the economy under exceptionally uncertain conditions.

Growth support and inflation trade-offs

The assessment contrasts with market expectations that the Bank of England is likely to hold rates and could even raise them this year as inflationary pressures re-emerge after the outbreak of the Iran war. The fund says the UK economy remains resilient, but that the war in the Middle East is damping near-term prospects.

It expects the British economy to gradually recover as the shock dissipates. However, the IMF also says higher energy prices are likely to push inflation up temporarily and delay the return to the central bank’s 2% target by about a year.

Under its current energy price outlook, the IMF says holding rates for the remainder of the year should still be enough to bring inflation back to target by the end of 2027. It also calls on the Bank of England to make decisions on a meeting-by-meeting basis and to communicate clearly that policy remains driven by incoming data.

Our earlier article on Bank of England policymaker Megan Greene’s warnings about repeated supply shocks explained why officials cannot assume the Iran war’s inflation impact will fade quickly. We noted that higher energy prices could feed into wages and broader pricing with a lag, raising the risk of second-round effects and keeping the BoE’s rate path uncertain, with split views on whether hikes might be needed.

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