The UK must focus on enhancing its economy’s productivity and international competitiveness in order to weather the shock of Brexit, the International Monetary Fund has warned.
In its latest country report published on Wednesday, the IMF reiterated that the British economy had faced challenges since June 2016’s referendum on EU membership, which triggered a sharp drop in the value of sterling, pushing up inflation and depressing private consumption.
“Business investment growth has been constrained by continued uncertainty about the future trade regime,” the organisation wrote in its report.
“UK growth moderated in 2017 despite significant monetary policy accommodation and strong trading partner growth, and is expected to remain subdued in the near term,” it added.
Over the medium term, the organisation said that growth prospects “will depend on the extent of recovery of labour productivity, which has been very low since the financial crisis”. It expects the economy to expand by 1.6 per cent this year, and forecasts that growth for last year will come in at 1.8 per cent.
The UK economy grew by 1.9 per cent in 2016, 2.3 per cent in 2015 and 3.1 per cent in 2014.
In terms of specific recommendations related to Brexit, the Washington-based organisation said that an agreement that minimises barriers to the cross-border flow of services, goods, and workers would best support growth in the UK over the coming years.
“Early agreement on a transition period would avoid a cliff edge exit in March 2019 and reduce the uncertainty now facing firms and households,” it said. “Continued steady fiscal consolidation, with an emphasis on pro-growth spending and tax reforms, remains critical to rebuild fiscal buffers and maintain investor confidence.”
The IMF also said that the Bank of England should continue to withdraw monetary stimulus “at a gradual pace” and that policymakers should respond flexibly to data developments.
The Bank raised interest rates for the first time in a decade in November to 0.5 per cent. At its policy meeting last week it kept rates on hold, but hinted that another raise could be on the cards imminently.
In November, Governor Mark Carney said two more rate rises would probably be necessary by the end of 2020 to keep inflation at the official 2 per cent target.
Financial markets at that time were pricing in another rate rise late this year and another in the second half of 2020.
Now many are pricing in the next hike to happen as soon as May and for there to be at least three rate hikes over the next three years.
The IMF said that its growth forecasts for the UK economy were based on the assumption that the EU and the UK make “smooth progress in negotiations that lead to an understanding on a broad free trade agreement and then transition smoothly to that new arrangement”.
The prognosis presumes that the UK exits the customs union and the single market, but that tariffs on goods traded with the EU stay at zero and that non-tariff costs increase only moderately.
And it also assumes that the UK reaches an agreement with the EU that allows banks and other financial firms to continue to provide most of their services on a cross-border basis.
Overall, however, the IMF admits that the full and final impact of Brexit will depend on a number of factors and might not be clear for many years.
For example, it says that industries like agriculture and tourism “could be affected by limits on immigration from the EU”.
“These developments could also have a significant impact on productivity growth.”