Washington, DC: International Monetary Fund (IMF) Executive Board concludes Article IV consultations [1] with Great Britain.

The UK economy enters 2020 with some challenges but also with some strengths. The main challenges include agreeing a post-Brexit trade deal with the EU, weak productivity growth, large regional disparities in income, population aging (and its impact on pension spending), and the need to strengthen climate policy. At the same time, the economy is operating at full employment, inflation is close to target, household and corporate debt burdens have fallen substantially since 2009, the banking system is well capitalized and liquid, and fiscal adjustments have set debt on a downward trajectory. , with the available fiscal space.

The pandemic has taken significant human and economic casualties, tempered by an aggressive policy response. More tragic health effects could be averted with the spring lock, subsequent lockdowns and a second lockout announced in early November. These health restrictions hit economic activity hard, with a sharp fall in GDP in Q2. Nonetheless, a coordinated fiscal, monetary and financial sector policy response has helped curb unemployment and bankruptcy. Despite the rebound as the economy reopens in the summer, growth for 2020 is likely to be around -11 percent, with core inflation below target, and the account deficit currently under control at around 2½ percent.

The prospects are challenging. The second lockout has reduced activity. The prolonged social distancing thereafter and the friction associated with the adoption of the new Brexit trade regime are expected to produce strong barriers until mid-2021 (and even longer if a free trade agreement cannot be reached). However, as full reopening occurs aided by vaccines, GDP is projected to recover and grow by 5.7 percent in 2021 and around 4.5 percent in 2022. A faster recovery will be held back by corporate and household pressure due to fiscal support shocks subsided and the economy adjusted structurally to the new landscape after the immediate effects of Covid and Brexit receded. By 2025, output levels are projected to recover to about 5 percent below their pre-Covid trend, reflecting temporarily weaker investment and higher unemployment. The risks to the outlook point to the downside, centering on the speed with which the impact of the pandemic is fading and the degree of damage to the balance sheets experienced by households and small and medium enterprises. Faster vaccine deployment can reduce risk.

Executive Board Assessment [2]

The directors noted that the pandemic has caused significant human and economic casualties in a British economy already facing the pressure of Brexit and long-term challenges. They lauded the authorities’ strong and coordinated policy response, which had helped reduce the damage. With uncertainty still high, the Directors stressed that policy support will remain essential to see the economy through the pandemic and transition to a post-Brexit trading regime.

The directors stressed that fiscal policy must continue to fund targeted pandemic support programs. They underscore the need to be prepared to respond if further downside risks materialize and welcome the flexibility of the authorities in this regard. As the pandemic subsides, targeted fiscal support using the available space can help drive growth. The directors welcomed the authorities’ plans to expand public investment and recommended an assessment of the adequacy of the public investment management framework.

The directors stressed that the gradual fiscal consolidation needed to contain the debt burden in the medium term, should only start after the private sector leads the recovery strongly. They see benefits in a full expenditure review to prepare for consolidation. A number of directors also suggested being open to considering some adjustments to the main tax rate and exploring fiscal measures to support the climate agenda. In this context, the Director set a positive note on the UK’s ambitious climate plan.

The Board of Directors considers that monetary policy must remain accommodative and welcomes the Bank of England’s commitment to increase government bond purchases. They generally note that negative policy rates can be part of the toolkit but recommend further study of how best to implement them. The Board of Directors emphasizes the role of the financial system in financing recovery. While recognizing the bank’s sizeable buffer, they cautioned that the uncertainty related to pressure on SMEs and commercial property prices requires continued oversight.

The directors underlined that adjusting to the pandemic and Brexit would require some reallocation of labor and capital. They see room to further strengthen social safety nets, enhance active labor market policies, streamline bankruptcy procedures, and open up equity financing.

The directors lauded the UK’s enviable track record of policy frameworks. They suggest considering updating the fiscal framework if needed once the uncertainty subsides. Whether the monetary framework may require adjustments to address the risk of persistent low inflation is also worth considering. The 2021 FSAP will also be an opportunity to consider emerging financial sector challenges.

The directors stressed that a deal on a new post-Brexit trade regime would benefit Britain and the EU and reduce spillovers to the outside. They welcomed the steps being taken to eliminate systemic financial sector risks and urged British authorities to complete preparations for trade infrastructure. An emergency plan will be needed if no agreement is reached. In such a scenario, it is important to keep expectations tied and pursue stronger policy support.