The International Monetary Fund has issued a tough assessment of U.K. economic policy, urging the coalition government and Bank of England to do more to boost demand in the economy.
The IMF's report of its latest consultation with British authorities released Tuesday called for more stimulus, either through further rounds of quantitative easing or by a further cut in the all-time low base lending rate of 0.5 percent.
Since coming to power in 2010, the UK coalition government has introduced an extensive austerity program of state spending cuts and reforms aimed at bringing down the country's deficit. However, as the IMF reports states, that while the U.K. has "made substantial progress toward achieving a more sustainable budgetary position", the country has fallen back into recession and "the hand-off from public to private demand-led growth has not fully materialized."
The Bank of England, meanwhile, has been working hard to keep inflation — which halts income growth and squeezes household spending — down to a target 2 per cent. Latest figures released Tuesday show that consumer price inflation fell from 3.5 percent in March to 3 percent in April, a bigger drop than expected.
The BoE has also paused in its program of quantitative easing — buying high-quality assets to free up the flow of money in the economy — after spending 325 billion pounds ($513 billion) to support the economy.
The IMF said that by cutting rates and introducing another round of QE "inflation could take longer than expected to return to target, with convergence being further delayed by additional monetary easing. Nonetheless, the cost of such a delay is likely to be low relative to the benefits of a more rapid closing of the output gap."
The drop in April's consumer price inflation does give the government and BoE added leeway to respond to the IMF's call for more action to boost demand. "The signs are that the Bank of England is keeping the door fully open to more QE given the major uncertainties over both the growth and inflation outlooks," said Howard Archer, European economist at HIS Global Insight.
The IMF also warned that the difficulties facing the economy of 17 country eurozone — which is the U.K.'s biggest export market — is the biggest threat to the U.K. economy.
"An escalation of stress in the euro area could set off an adverse and self-reinforcing cycle of lower confidence and exports, higher bank funding costs, tighter credit, and falling asset values, resulting in a substantial contractionary shock," the IMF said.
While the government will be encouraged by the inflation data, the April budget surplus of 16.5 billion pounds was below the market consensus of 20 billion pounds. The transfer of Royal Mail pension fund assets pushed the account into surplus for the month.
The government's tax take was down 0.9 percent compared to a year earlier. Excluding the pension fund effect, "the deficit of 11.5 billion pounds looks pretty nasty," said Vicky Redwood, chief U.K. economist at Capital Economics.