IMF backs UK policy but warns of growth risks

By David Milliken

LONDON, June 6 (Reuters) – The International Monetary Fund backed the British government’s plans to reduce the budget deficit on Monday, but said that tax cuts or more quantitative easing may be needed if growth proves persistently weak.

Britain’s economy is likely to grow by around 1.5 percent in 2011 before rising to 2.5 percent in the medium term, the IMF estimated, but it acknowledged that there were significant risks around this forecast, as there were for all major economies.

These risks include euro zone debt problems, volatile commodity prices, the health of Britain’s housing market and the amount of spare capacity in the UK economy, the IMF said.

Finance minister George Osborne welcomed the IMF’s annual economic assessment, which comes after he dismissed criticism from more than 50 left-leaning economists over the weekend that his plans risked derailing economic recovery.

If the economy grew as expected, then government and Bank of England policy looked about right, the IMF said.

“We consider the current deviations from forecast represent temporary factors and that the current policy mix strikes us as appropriate,” IMF acting managing director John Lipsky told a news conference after report was published.

However, the IMF said that if growth proved persistently slow and inflation fell, then the Bank of England would need to consider more quantitative easing — injecting money into the economy — and the government should think about tax cuts to help the poor and boost investment.

The IMF said that inflation was likely to remain above 4 percent this year before falling back to near its 2 percent target by the end of next year. If growth strengthened as expected, the BoE would probably also need to raise interest rates at a gradual pace, it added. Faster growth would require a faster pace of rate rises.

If inflation remained high and growth slow, the government and BoE would be in a trickier position. While high inflation due to further temporary spikes in commodity prices could probably be ignored, inflation caused by a shortage of capacity in the British economy would need higher interest rates.

“A narrower output gap would also imply a higher-than-currently estimated structural deficit and therefore would require further fiscal tightening over the medium term,” the IMF said. (Additional reporting by Matt Falloon and Fiona Shaikh; Editing by Toby Chopra)