Since the outbreak of the conflict involving Iran, renewed inflationary pressures in the UK have disrupted monetary policy expectations. Markets had previously anticipated the Bank of England would hold rates steady this year, with some even pricing in a potential hike.
However, the International Monetary Fund, which on Monday raised its UK growth forecast for 2026, stated that the Bank of England should be prepared to cut interest rates if necessary.
In its latest UK economic assessment, the IMF said, "Monetary policy should remain restrictive to ensure energy price increases do not spill over into core inflation and wage growth."
The organization added, "Higher energy prices will push up headline inflation this year while also weighing on output, complicating the calibration of policy."
The IMF stated that keeping the Bank of England's key policy rate—the Bank Rate—at its current level of 3.75% for the remainder of the year would "maintain a sufficiently restrictive monetary policy stance to limit second-round effects and anchor long-term inflation expectations."
But the IMF also noted that the Bank of England should be ready to cut rates to support the economy if required.
The IMF pointed out, "Given the high degree of uncertainty, the Bank of England should retain the flexibility to adjust the monetary policy stance in either direction and be prepared to act decisively if second-round effects prove stronger than anticipated."
GDP Growth Forecast Revised Upward In a rare piece of positive economic news for the UK, the IMF on Monday raised its growth forecast for the UK this year to 1.0%, up from a previous estimate of 0.8%.
The organization noted, "While the UK economy has shown resilience in recent years, conflict in the Middle East is dampening its near-term prospects."
The IMF stated it expects the UK economy to "recover gradually" as shocks dissipate.
The organization added that higher energy prices could temporarily boost inflation and delay the return to the central bank's 2% target by about a year.
The IMF said, "Under the current energy price outlook, keeping rates on hold this year should be sufficient to bring inflation back to target by the end of 2027."
It called on the Bank of England to ensure policy decisions are communicated clearly, are data-dependent, and follow a meeting-by-meeting approach.
In its spring forecasts, the IMF had warned that the UK would be the hardest-hit among wealthy economies due to the conflict involving Iran. However, on Monday, the organization acknowledged that the UK economy's resilience so far has exceeded expectations. Data released last week showed the UK economy grew by 0.6% in the first quarter, better than anticipated.
The IMF noted, "Once the energy price shock fades, growth should recover in the second half of 2027 and stabilize around its potential rate over the medium term."
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