The International Monetary Fund has urged the Bank of England to act early to curb inflation as BoE policymakers set to meet for the last time in 2021.
In its annual review of the UK economy, the IMF said the BoE had a difficult job but putting off action could allow inflation to get out of hand. The BoE’s monetary policy committee meets this week and will announce its decision on interest rates on Thursday.
“Monetary policy needs to withdraw the exceptional support provided during 2020-21,” the fund said. “Policymakers will have to weigh risks. On the one hand early action could slow the recovery at a point when its sustainability is not assured; on the other hand, inaction could allow second-round effects of inflation to proliferate.”
The IMF said monetary policy faced “difficult trade-offs” but that initial steps to tighten policy would leave conditions loose and help dampen expectations for inflation. Inflation is a risk now but in two or three years the risk shifts to lower growth, the fund said.
Economic growth will be about 6.8% in 2021 with a slight slowdown in the first quarter of 2022 because of restrictions to stem Omicron infections, the IMF said. The UK economy will expand by about 5% in 2022, it predicted.
UK inflation will peak at about 5.5% in spring 2022 before returning to the BoE’s 2% target by early 2024, the IMF said. Real output will settle at 2-2.5% less than its pre-pandemic trend, held back by weak investment and employment trends, the fund predicted.
“The Bank of England’s monetary policy committee has the tools to address volatility including discretion to manage the path of inflation back to its targeted level,” the IMF said. “However, it would not be a simple matter to see through extended shifts in relative wages and prices while keeping expectations anchored.”
“It would be important to avoid inaction bias, in view of costs associated with containing second-round impacts. Careful communication would be needed to lay the groundwork with markets for potentially more frequent policy moves.”
Strong jobs data on Tuesday might otherwise have prompted the MPC to increase interest rates from their all-time low on Thursday but the rapid spread of the Omicron strain and uncertainty over its impact suggest the committee will hold off until the new year.