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IMF Casts Doubt on UK Deficit Plan

Bad economic news bombarded the British Treasury on Monday as new International Monetary Fund forecasts cast doubt on the chancellor’s deficit reduction plan, while near-term indicators suggested the recovery was losing the little momentum it had.

Tower Bridge and City of London financial district
Source: Dominic Burke | Getty Images
Tower Bridge and City of London financial district

The IMF judged that Britain’s economy had less capacity to grow quickly over the next few years than the government had hoped, slowing the reduction in borrowing to the point where it comes within a whisker of missing George Osborne’s main fiscal target.

Instead of eliminating his preferred measure of the deficit with billions to spare a year before the next election, Ajai Chopra, the IMF mission chief to the UK warned that the chancellor’s “mandate is met with a very slim margin”, raising the possibility that further spending cuts and tax rises would be needed.

The IMF assessment came as figures showed manufacturing activity had all but ground to a halt as the third quarter started. The Markit/CIPS purchasing managers’ index fell to 49.1 in July from 51.4 in June. The weakness persuaded investors that the Bank of England was extremely unlikely to raise interest rates in the near future, pushing the UK’s benchmark borrowing costs close to their lowest levels.

Yields on 10-year Gilts fell to 2.797 percent, just above their all-time low of 2.794 percent from last August and far below their level as recently as February when they were at 3.89 percent.

Presenting the IMF’s annual health check on the UK economy, Mr Chopra stuck to his initial view from June that there was no need yet for any change in the government’s austerity drive, but it should be ready to alter its strategy as circumstances unfolded, he added.

The Treasury latched on to this support with a spokesperson saying: “The IMF has again endorsed Britain’s strategy for reducing our deficit and dealing with our debt”.

Most worrying for households was the Fund’s new assessment that structural unemployment is significantly higher than the OBR believes. Drawing on evidence from the past economic cycle, it estimated a long-term unemployment rate of 6.8 percent or 2.2 million people, nearly 300,000 more than the official estimate of 1.9 million or 5.25 percent of the labour force.

With the IMF expecting the economy to struggle to reduce unemployment, deficit reduction becomes more difficult and the experts from Washington estimate the current structural budget will only just crawl into surplus in 2015-16 by 0.1 percent of national income.

Mr Chopra refused to endorse Labour’s Plan B of immediate tax cuts. Only if the economy appeared “likely to experience a prolonged period of weak growth and high unemployment” should monetary policy be loosened and the government consider temporary tax cuts.

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