I.M.F. Backs Britain’s Recovery Efforts

LONDON — The International Monetary Fund endorsed Monday the British government’s tight budget policy and loose monetary stance, while warning that the authorities should stand ready to change course if growth did not gather pace.

In a regular report on the British economy, the fund noted the weak economic environment and an increase in inflation had raised questions about whether macroeconomic policies should be adjusted. “The answer is no,” the report said, “as the deviations are largely temporary.”

Britain has been cutting spending and raising revenue to bolster its weak fiscal position, a legacy of the financial crisis, when it spent public funds to bail out large lenders like Royal Bank of Scotland, Lloyds Banking Group and Northern Rock.

The crisis pushed the fiscal deficit to 11 percent of gross domestic product in the 2009-10 financial year, the highest level since World War II and one of the highest rates in the world. The deficit fell to 9.75 percent in the 2010-11 financial year, and the I.M.F. said a further decline to 8 percent was expected for the following year.

Strong fiscal consolidation “remains essential to achieve a more sustainable budgetary position, thus reducing fiscal risks,” the fund said.

It forecast that growth would pick up to 1.5 percent in 2011 from 1.4 percent last year, and accelerate to 2.3 percent in 2012. Inflation is expected to decline to 2.2 percent next year from 4.5 percent this year.

The current high inflation rates are driven by transitory factors, it said, “and hence maintaining the current scale of monetary stimulus is appropriate given fiscal adjustment and subdued wage growth.”

Still, the fund cited “significant risks to inflation, growth, and unemployment arising from uncertainties surrounding sovereign turmoil in parts of the euro area, headwinds from fiscal policy, volatile commodity prices, and the housing market.”

And the authorities will need to retain flexibility to respond to shocks, the report added.

“If there is mounting evidence that weak demand is likely to cause the economy to stall and enter a period of prolonged low growth and subdued inflation, a significant loosening of macroeconomic policies will be required,” it said.

For British banks, a continued buildup of capital and liquidity buffers remains essential, the fund said. Needing to refinance a large amount of government support as well as private-sector debt over the next two years, banks will remain vulnerable to higher financing costs and disruptions in wholesale funding markets, it warned.

The high level of indebtedness of households and some companies aggravates these vulnerabilities. And weak home prices are likely to weigh on consumption going forward, the fund said, forecasting a reduction in the house price-to-income ratio of 12 percent over the medium term.

Article source: http://www.nytimes.com/2011/08/02/business/global/imf-backs-britains-recovery-efforts.html?partner=rss&emc=rss