11 December 2015

IMF: United Kingdom—2015 Article IV Consultation Concluding Statement of the Mission

Outlook and Risks

1. The UK’s recent economic performance has been strong, and considerable progress has been achieved in addressing underlying vulnerabilities. Growth has exceeded that of the other major advanced economies, the unemployment rate has fallen substantially, employment has reached an historic high, the fiscal deficit has been reduced, and financial sector resilience has increased.

2. Steady growth looks likely to continue over the next few years, and inflation should gradually return to target. After a period of robust private domestic demand-driven growth, matched by steady increases in employment, the economy now looks to be running near capacity. Investment has contributed to domestic demand growth, and recent increases in productivity give cause for cautious optimism about growth in real incomes. As labor market slack is used up, the mission expects growth to slow slightly in 2016 and to average around 2¼ percent over the medium term. Inflation is expected to revert to target gradually, as effects from commodity price falls and sterling appreciation dissipate and wages increase.

3. There are, however, a number of risks to this broadly positive outlook. In particular, domestic and external imbalances persist, and while there are often mitigating factors that offset some of the associated risks, these imbalances remain, in an absolute sense, large:

• House price growth has eased somewhat over the past year, but remains high. [...]

• The current account deficit is similarly not a result of funding a household credit boom, but nonetheless is strikingly large. Notwithstanding a flexible exchange rate and independent monetary policy, confidence shocks could reduce external capital flows into the UK, which could adversely affect growth.

• The 2014/15 fiscal deficit stood at nearly 5 percent of GDP, with general government gross debt reaching 87 percent of GDP, despite steady progress in reducing fiscal imbalances. While the UK continues to benefit from record low interest rates, maintaining deficits and debts at these levels would constrain the space to respond proactively to future large negative growth shocks.

• In addition, there are other uncertainties that may affect the outlook. For example, the presumed recovery of productivity growth to nearer its historical average rate, which is essential to ensure that the growth of output and incomes remains solid, may fail to materialize. In addition, uncertainty associated with the outcome of the planned referendum on EU membership could weigh on the outlook. [...]

Macroeconomic Policies

4. The fiscal framework has been revised. A new fiscal rule specifies a surplus to be maintained in “normal” times, replacing the rolling cyclical mandate. The transparency of the new rule—with a focus on headline balances and a simple and well-defined escape clause in the event of very low growth—is welcome. The “comply or explain” nature of the rule, which requires the Chancellor to explain to Parliament any deviation from the rule but does not mandate any specific sanctions, adds another appropriate level of flexibility.

5. The Autumn Statement appropriately targets steady declines in the deficit and the achievement of a small surplus by 2019/20. Notably, the envisaged path of deficit reduction over the medium term is smoother than foreseen at the time of the 2014 Article IV consultation. [...]

6. More neutrality in the tax system could help promote efficiency and stability.

• Scaling back distortionary tax expenditures (e.g. nonstandard zero VAT rates) could free up resources for other uses, including higher spending on priority items such as infrastructure.

• Property tax reform, along the lines recommended in the Mirrlees Review, could help reduce vulnerabilities in the housing market by easing supply constraints. For example, rebalancing taxation away from transactions and towards property values could boost mobility and facilitate more efficient use of the housing stock. Reducing council tax discounts for single-occupant properties could also increase the utilization of these properties.

• Reducing the tax code’s bias toward debt, possibly by adopting an Allowance for Corporate Equity with offsetting changes in other corporate tax parameters, could also promote financial stability.

7. Monetary policy should stay on hold until inflationary pressures are clearer. Headline inflation remains well below target, and core inflation is subdued. The mission sees a strong case for the Bank of England to maintain the policy rate at 0.5 percent and the stock of QE assets at £375 billion until signs of stronger inflationary pressures emerge. [...]

Financial Sector Policies

8. The authorities should continue to take a prudent and intrusive approach to financial sector regulation and supervision. [...]

9. Financial market conduct and culture remain concerns. Substantial conduct and litigation charges have been issued, and a return of public confidence in the ethical underpinnings of the financial system remains a ways off. The authorities have increased incentives for firms to clearly define individual responsibilities, making it easier to find and discipline individuals responsible for misconduct. Cultural changes are just as important as defining “hard” legal boundaries—to this end, the UK authorities’ efforts to promote a set of global standards for ethical behavior in the financial system are welcome.

The Housing Market and Macroprudential Policies

10. New macroprudential measures have eased but not eliminated risks to household finances. Affordability tests for prospective borrowers and limits on new mortgages with very high loan-to-income multiples have played a role in slowing house price growth, and the proportion of households with higher loan-to-income ratios has also fallen. Nonetheless, prices are still rising much faster than incomes. Properties bought for letting have accounted for over a third of gross mortgage growth; this market is dominated by small-scale landlords that could be relatively exposed if expected returns are not realized. [...]

11. Further macroprudential measures may be necessary. Tightened LTI limits or use of loan-to-value caps might be needed if shares of higher-leverage mortgages do not continue to fall. Priority should also be given to the consolidation of household-level credit data so as to allow an eventual shift from LTI limits to debt-to-income limits, as these are more comprehensive and hence more difficult to evade. [...]

Full statement

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