Commuters (left) cross an intersection near the Bank of England (BOE) in London, England, on Wednesday, May 8, 2024. Bank of England policymakers appear to be at their most divided since the end of the rate-hike cycle last year, underscoring the challenge Governor Andrew Bailey faces in steering colleagues towards possible rate cuts in the coming weeks. Photographer: Holly Adams/Bloomberg via Getty Images
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Inflationary pressures have risen again in the UK since the outbreak of the Iran war, and expectations for monetary policy have fluctuated widely, with the Bank of England expected to keep interest rates unchanged if not raise them this year.
But the International Monetary Fund, which on Monday revised up its UK growth forecast for 2026, suggested the central bank should be prepared to cut interest rates if necessary.
“Monetary policy should remain restrictive to prevent rising energy prices from spilling over into core inflation and wage increases,” the IMF said in its latest outlook for the UK.
“Rising energy prices will push up headline inflation this year, while also weighing on production and complicating policy adjustments,” it added.
The IMF said keeping the central bank’s key interest rate, known as the Bank Rate, at its current level of 3.75% for the rest of the year will “maintain a sufficiently restrictive monetary stance to limit second-order effects and keep long-term inflation expectations anchored.”
But he added that the BOE must be prepared to cut interest rates if necessary to support the economy.
“Given the exceptional uncertainty, the BOE should maintain the flexibility to adjust its monetary stance in either direction and be prepared to respond forcefully if the impact of the second round proves to be stronger than expected,” the IMF said.
Improving GDP growth rate
In a rare piece of good economic news for Britain, the IMF on Monday revised up its forecast for the country’s economic growth this year to 1% from its previous forecast of 0.8%.
“The UK economy has remained resilient in recent years, but the war in the Middle East has weakened the short-term outlook,” the fund said.
The IMF said it expects the UK economy to “recover gradually as the shock wears off.”
He added that rising energy prices could cause a temporary rise in inflation, delaying the central bank’s return to the 2% target by about a year.
“Based on the current energy price outlook, holding interest rates for the rest of the year should be sufficient to bring inflation back on target by the end of 2027,” the report said.
The Fund called on the BOE to ensure decisions are clearly communicated and based on data at each meeting.
The IMF had warned in its spring forecast that Britain would suffer the worst economic blow among rich countries from the Iran war, but on Monday acknowledged it had so far been more resilient than expected. Data released last week showed economic growth in the first quarter was 0.6%, faster than expected.
“Once the energy price shock subsides, growth should recover in the second half of 2027 and stabilize near potential over the medium term,” the IMF said.
