## UNITED KINGDOM — IMF Staff Report (cr18316)

## Source details

**Canonical URL:** [UNITED KINGDOM — IMF Staff Report (cr18316)](https://www.imf.org/-/media/files/publications/cr/2018/cr18316.pdf)

## Other formats

- [Markdown version](/-/media/files/publications/cr/2018/cr18316.pdf.md)
- [Structured JSON version](/-/media/files/publications/cr/2018/cr18316.pdf.json)

---

### Recent developments
- The United Kingdom is set to exit the European Union in March 2019.
- A 21-month implementation period was agreed—during which the UK will remain in the single market and the customs union, and abide by all existing EU rules—contingent on ratifying a withdrawal agreement and agreeing on a framework for the future relationship by March.
- Complex issues remain: future status of the land border with Ireland; trade, legal, and institutional relations after Brexit.
- Output growth: moderate in the two years since the referendum; private consumption constrained by slow real income growth.
- Business investment: lower than expected; part attributed to uncertainty about the future relationship and expectations of higher trade costs after Brexit.
- Past sterling depreciation increased inflation and depressed private consumption; inflation has moderated as those effects are fading.
- Potential growth: slowed over the last two years due to subdued productivity and diminished labor force growth, partly from a decline in net migration inflows from the EU.
- Slack diminished: unemployment fell to 4 percent in mid-2018 despite a record high labor force participation rate; wage growth has started to firm.
- Headline CPI inflation: declined to 2.7 percent in August from 3.0 percent in January; core inflation fell to 2.1 percent.
- Macroeconomic policy mix: mildly accommodative
  - Policy rate at 0.75 percent.
  - Staff’s estimate of the neutral rate: about 1½ percent.
- Credit and rates:
  - Consumer credit growth at 8.1 percent yoy in August.
  - Mortgage rates at record low levels; corporate lending rates have inched up reflecting some widening of bank funding spreads and global factors.

### Outlook and projections (baseline assumptions and central scenario)
- Baseline assumptions (summary):
  - Brexit negotiations conclude on schedule.
  - Culmination in a free trade agreement for goods.
  - Moderate increase in non-tariff barriers for services.
  - Smooth transition to the new equilibrium.
  - A tighter migration regime over the medium term.
- Under the central scenario:
  - Growth would remain modest around 1½ percent.
  - Export growth supported by steady global demand; imports expected to remain subdued, allowing net exports to make a small positive contribution to growth.
  - Household consumption expected to grow at a moderate pace, broadly in line with real disposable income growth.
  - Inflation projected to decline gradually toward the target over the next year.
  - Business investment supported in the near term by export demand and favorable financing conditions, but uncertainty will continue to constrain investment growth.
  - Labor productivity projected to recover somewhat; medium-term GDP growth expected to average around 1½ percent.
- Medium-term staff projections (selected):
  - Real GDP (percent change): 2018: 1.4; 2019: 1.5; 2020: 1.5; 2021: 1.6; 2022: 1.6; 2023: 1.6.
  - CPI Inflation, period average: 2018: 2.7; 2019: 2.5; 2020: 2.2; 2021: 2.0; 2022: 2.0; 2023: 2.0.
  - Unemployment rate (period average): 2018: 4.1; 2019: 4.2; 2020: 4.5; 2021: 4.5; 2022: 4.5; 2023: 4.5.
  - Potential output growth (percent): 2018: 1.4; 2019: 1.4; 2020: 1.5; 2021: 1.6; 2022: 1.6; 2023: 1.6.

### Risks and key downside / scenario analysis
- Largest risk: exit without an agreement with the EU (disorderly/no-deal Brexit), which could be accompanied by disruptive asset price movements.
- Other downside risks:
  - Continued weak productivity growth.
  - Protracted uncertainty depressing investment and slowing supply growth further.
  - Tighter global financial conditions raising corporate borrowing costs.
- Quantified scenario impacts (Box 2):
  - EEA scenario: estimated medium-term impact about a 1½ percent reduction in real GDP relative to a no-Brexit scenario.
  - FTA (staff baseline): estimated medium-term real GDP fall about 2½ to 4 percent (average about 3 percent) compared with a no-Brexit scenario.
  - WTO scenario: estimated decline in level of real GDP around 5 to 8 percent (average about 6 percent) compared with a no-Brexit scenario.
- External spillovers:
  - In an FTA scenario, the impact on Ireland ranges from nearly zero to almost 3 percent of GDP.

### Policy recommendations and priorities
- Fiscal policy:
  - Sustained fiscal consolidation to restore fiscal buffers and prepare public finances for expected demographic-related spending.
  - Continued gradual consolidation envisaged over the next three years.
  - Allow automatic stabilizers to operate freely; additional temporary spending may be warranted if smoothing adjustment is needed, embedded in credible medium-term consolidation plans.
- Monetary policy:
  - Pace of further tightening should be gradual and data-dependent given high uncertainty.
  - Policymakers should remain ready to respond flexibly to data developments; accommodative conditions should be maintained longer if negative Brexit-related surprises depress domestic demand.
- Financial sector policy and supervision:
  - Continued focus on strict prudential supervision given relatively easy financial conditions and Brexit-related risks.
  - Close collaboration with EU prudential authorities essential to maintain smooth functioning of the financial system and minimize risks.
  - Keep the CCyB rate under review; continue timely adoption of Basel III final agreement.
- Structural reforms:
  - Boost productivity and facilitate reallocation of resources post-Brexit.
  - Strengthen human capital, boost housing supply, increase public investment, and raise public and private R&D spending.
  - Facilitate transition supporting workers rather than particular jobs or sectors (retraining, relocation support, entrepreneurship).
- Contingency planning:
  - Prepare for no-deal outcome; contingency planning and preparedness measures for a no-deal outcome are critical.

### Monetary policy and Bank of England guidance
- Monetary stance and actions:
  - Monetary policy remains accommodative despite a cumulative 50 basis point increase in Bank Rate over the last 12 months.
  - Bank of England raised the policy rate by 25 basis point to 0.75 percent in August.
  - Nominal policy rate is still below Fund staff’s estimated neutral rate of about 1½ percent.
  - MPC voted to maintain the stock of gilts and corporate bonds on the Bank’s balance sheet.
- Bank of England strategy:
  - Bank intends to continue to use Bank Rate as the main policy instrument.
  - MPC does not intend to start reducing the stock of purchased assets until Bank Rate reaches around 1.5 percent.
  - Staff agreed the Bank should start reducing its balance sheet in a gradual and predictable manner when appropriate.
  - The Bank expects to continue using a floor system to control short-term interest rates; long-run central bank balance sheet size likely higher than pre-crisis.
- Inflation and labor costs:
  - Unit labor costs increased by about 2½ percent yoy in the first half of 2018 and are projected to remain relatively high in the near term.
  - High energy prices expected to keep headline inflation above 2 percent for the rest of 2018, with gradual convergence to target projected next year.
- Policy guidance summary:
  - A modest further tightening of monetary policy over the next two years would likely be needed if excess demand pressures persist after domestic inflation reaches the level consistent with the 2-percent target.
  - Future increases in the Bank Rate are likely to be gradual and limited.

### Financial sector resilience, supervision, and contingency planning
- Banks' balance-sheet strength:
  - Authorities raised the countercyclical capital buffer requirement from 0.5 to 1 (effective as of November 2018).
  - 2017 BoE stress test suggests UK banking system resilient to deep simultaneous recessions and large falls in asset prices.
  - Banks subject to ringfencing requirements on track to meet January 2019 deadline.
- Profitability and indicators (selected presented figures)
  - Basel III common equity Tier 1 capital ratio and other indicators presented in source (tabulated values preserved in original).
  - "Foreign investors accounted for 50 percent of transactions in UK CRE in 2018 Q2."
- Supervision recommendations:
  - Continue prudent supervision; adjust bank-specific capital buffers to match risk exposures.
  - Timely adoption of Basel III final agreement and guidance on hybrid models.
  - Monitor market-based finance and develop system-wide stress simulation covering non-bank firms.
  - Continue efforts to mitigate cyber security risks.
- Brexit-related preparedness in financial sector:
  - Temporary permission regime would allow EEA financial firms operating in the UK via a passport to continue regulated activities for up to three years after exit (awaiting parliamentary ratification).
  - Authorities noted domestic banks' capital ratios have tripled since end-2007 and are adequate to withstand a range of shocks.
- Contingency actions in disorderly Brexit:
  - Ensure adequate capitalization, temporary permissions, liquidity provision; countercyclical buffer could be released to support bank credit supply if confidence and resilience maintained.
  - 2018 annual stress test should be used to gauge banking system’s strength to withstand Brexit-associated risks.

### External sector assessment (Annex I) — key points
- Overall assessment:
  - External position in 2017 was weaker than implied by medium-term fundamentals and desirable policy settings; preliminary data suggest assessment broadly unchanged for 2018.
  - NIIP declined from -2.4 percent of GDP in 2016 to -8.6 percent of GDP in 2017.
  - Staff projects NIIP to weaken over the medium term; valuation effects and uncertainty important.
  - Staff assesses the 2017 cyclically-adjusted CA balance to be 1 to 5 percent of GDP weaker than the CA norm, with a mid-point of 3 percent of GDP.
- Current account (selected):
  - CA balance improved to -3.9 percent of GDP in 2017 (from -5.2 percent in 2016); expected to further improve to -3.5 percent of GDP in 2018.
  - EBA CA model estimates a CA gap of -4.8 percent of GDP for 2017 (EBA CA Norm 1.0; Cycl. Adj. CA -3.8).
- Real exchange rate (REER) assessment:
  - Sterling depreciated by 10 percent in 2016 in real effective terms relative to 2015 and by additional five percent from 2016 to 2017.
  - EBA REER approaches suggest a gap of -9.3 and -10.0 percent for 2017.
  - Staff assesses the REER to be between 0 and 15 percent above the level consistent with fundamentals and desirable policy settings.
- Capital and financial accounts:
  - Given UK’s role as an international financial center, portfolio investment and other investment are key components and large fluctuations are inherent.
- Reserves and FX intervention:
  - Pound has the status of a global reserve currency; reserves held by the UK are typically low relative to standard metrics; currency is free floating.

### Public debt, fiscal projections, and stress tests
- Debt-to-GDP dynamics (baseline and stress highlights):
  - Debt-to-GDP ratio peaks at around 96 percent of GDP in FY19 and drops below 90 percent by FY21.
  - Gross financing needs rise to around 12 percent of GDP by FY20.
  - Nominal gross public debt (selected): 77.9 (2016), 96.3 (2017), 95.5 (2018), 95.5 (2019), 94.4 (2020), 90.9 (2021), 86.6 (2022), 85.6 (2023), 84.6 (projection labeling preserved).
  - Public gross financing needs (selected): 11.4 (2016), 9.1 (2017), 9.6 (2018), 8.3 (2019), 9.3 (2020), 9.9 (2021), 8.4 (2022), 7.2 (2023), 8.2 (projection labeling preserved).
- Stress-test scenarios:
  - Interest rate shock: a 224 basis point increase in interest rates assumed from FY19 on; effective interest rate edges up to 2.6 percentage points by FY23/24.
  - Exchange rate shock: a depreciation of 37 percent assumed for FY19; this reduces the debt ratio via denominator effects.
  - Combined macro-fiscal scenario: debt-to-GDP reaches nearly 99 percent in FY20 and declines to around 95 percent by FY21; gross financing needs would rise to 13 percent by FY20.
  - Contingent fiscal shock (banking crisis): one-time bail out raising non-interest expenditure by 3 percent of banking sector assets in FY19; debt-to-GDP would rise to about 110 percent in FY19 and gross financing needs would peak at 21 percent of GDP.
- Policy guidance:
  - Sustained consolidation recommended to reduce debt-to-GDP; baseline consolidation (balanced budget by mid-2020s) would help debt decline to about 70 percent in ten years absent shocks.
  - Any policy easing should be temporary and anchored in credible medium-term fiscal consolidation plans.

### Structural reforms, productivity, and inclusiveness priorities
- Productivity:
  - Productivity growth projected to rise to about 1 percent (still well below pre-crisis levels).
  - Investment in labor-saving technologies and improved efficiency of labor utilization expected to support productivity as economy at full employment.
- Structural reform priorities:
  - Housing supply: ease planning restrictions and reform property taxes.
  - Infrastructure: increase public investment; close infrastructure gap.
  - Human capital: monitor and evaluate T-levels and apprenticeship funding reforms; expand basic skills of high-school graduates.
  - Research and development: public and private R&D spending relatively low; government pledge to increase public investment in R&D is welcome.
  - Decentralization: greater role for local decision-making with adequate equalization mechanisms.
- Gender and labor-market participation:
  - Female participation rate is 74 percent.
  - Fully closing the participation rate gap would boost output by around 5 to 6 percent in the long run.
  - Gender pay gap: 10 percent on average for full-time employees.
  - Policy recommendations: facilitate job sharing, compressed work schedules, increase female representation in senior positions and corporate boards.

### Corporate transparency, anti-corruption, and enforcement
- Anti-foreign bribery enforcement:
  - OECD Working Group commends UK’s enforcement efforts and political commitment; legislative reforms like deferred prosecution agreements and SFO actions noted.
  - Enhanced whistleblowing channels and SFO intelligence analysis improved detection capabilities.
- OECD Working Group recommendations (areas of focus):
  - (i) maintain SFO role in foreign bribery cases;
  - (ii) improve interagency cooperation and safeguard independence of investigations;
  - (iii) improve coordination of law enforcement between England, Wales, and Scotland;
  - (iv) enhance AML reporting framework to improve detection of foreign bribery;
  - (v) strengthen engagement with the CDBOT regarding detection and enforcement;
  - (vi) conduct comprehensive review of HMRC capacity to detect and report foreign bribery.
- Authorities’ actions:
  - Progress on PSC and private trust registers; public consultation for register of overseas legal entities owning UK real estate; beneficial ownership required for certain central government procurement; increased SFO budget; creation of National Economic Crime Centre.
- Fund staff urges continued implementation of recommendations and further enforcement, including in Crown Dependencies and BOTs.

### Key economic and fiscal indicators (selected, exact values preserved)
- Real GDP (change in percent): 2014: 2.9; 2015: 2.3; 2016: 1.8; 2017: 1.7; 2018: 1.4; 2019: 1.5.
- CPI, end-period (percent): 2014: 1.0; 2015: 0.1; 2016: 1.2; 2017: 3.0; 2018: 2.3; 2019: 2.1.
- Unemployment rate (in percent) 2/: 2014: 6.2; 2015: 5.4; 2016: 4.9; 2017: 4.4; 2018: 4.1; 2019: 4.2.
- Gross national saving (percent of GDP): 2014: 12.3; 2015: 12.3; 2016: 12.0; 2017: 13.6; 2018: 13.7; 2019: 14.0.
- Public sector overall balance (fiscal year, percent of GDP) 3/: 2014: -4.9; 2015: -3.8; 2016: -2.3; 2017: -1.9; 2018: -1.9; 2019: -1.5.
- Public sector net debt (percent of GDP): 2014: 82.6; 2015: 82.3; 2016: 85.2; 2017: 85.3; 2018: 85.5; 2019: 84.7.
- Current account balance (percent of GDP): 2014: -4.9; 2015: -4.9; 2016: -5.2; 2017: -3.8; 2018: -3.5; 2019: -3.2.
- Exchange rate (Bilateral rate, October 5, 2018): US$1 = £0.7832.
- Net investment position (percent of GDP), projections: 2018: -11.5; 2019: -14.4; 2020: -17.1; 2021: -19.6; 2022: -21.9; 2023: -24.1.

*Source: IMF staff report, cr18316 — United Kingdom (selected excerpts).*

### 2019. It is now in the process of negotiating its withdrawal from the EU. Once an

### UNITED KINGDOM — IMF Staff Report (October 25, 2018)

### Recent developments
- The United Kingdom is set to exit the European Union in March 2019.
- The two sides have agreed to a 21-month implementation period—during which the UK will remain in the single market and the customs union, and abide by all existing EU rules—but this is contingent on ratifying a withdrawal agreement and agreeing on a framework for the future relationship by March.
- Complex issues remain to be resolved, including the future status of the land border with Ireland and the outline of trade, legal, and institutional relations after Brexit.
- Output growth has been moderate in the two years since the referendum; private consumption has been constrained by slow real income growth.
- Business investment remains lower than expected given robust global growth and favorable financing conditions; staff analysis attributes part of this to uncertainty about the future relationship and expectations of higher trade costs after Brexit.
- The past sterling depreciation increased inflation and depressed private consumption, but inflation has moderated as those effects are fading.
- Potential growth has slowed over the last two years due to subdued productivity and diminished labor force growth, partly from a decline in net migration inflows from the EU.
- Slack in the economy has diminished despite weak demand; the unemployment rate fell to 4 percent in mid-2018 despite a record high labor force participation rate, and wage growth has started to firm.
- Headline CPI inflation declined to 2.7 percent in August from 3.0 percent in January; core inflation fell to 2.1 percent.
- The macroeconomic policy mix is mildly accommodative:
  - Policy rate at 0.75 percent.
  - Staff’s estimate of the neutral rate: about 1½ percent.
- Total credit is growing in line with GDP, although consumer credit expansion remains high:
  - Consumer credit growth at 8.1 percent yoy in August.
- Mortgage rates are at record low levels; corporate lending rates have inched up reflecting some widening of bank funding spreads and global factors.

### Outlook (baseline assumptions and projections)
- The outlook is subject to significant risks, primarily reflecting uncertainty about the outcome of Brexit negotiations.
- Baseline scenario assumptions (summary):
  - Brexit negotiations conclude on schedule.
  - Culmination in a free trade agreement for goods.
  - A moderate increase in non-tariff barriers for services.
  - A smooth transition to the new equilibrium.
  - A tighter migration regime over the medium term.
- Under the central scenario:
  - Growth would remain modest around 1½ percent.
  - Export growth supported by steady global demand; imports expected to remain subdued, allowing net exports to make a small positive contribution to growth.
  - Household consumption expected to grow at a moderate pace, broadly in line with real disposable income growth.
  - Inflation projected to decline gradually toward the target over the next year.
  - Business investment supported in the near term by export demand and favorable financing conditions, but uncertainty will continue to constrain investment growth until greater clarity on post-Brexit trading arrangements.
  - Labor productivity projected to recover somewhat; over the medium term GDP growth expected to average around 1½ percent.

### Risks and key downside scenario
- The largest economic risk is an exit without an agreement with the EU (disorderly/no-deal Brexit), which could be accompanied by disruptive asset price movements.
- Other downside risks include:
  - Continued weak productivity growth.
  - Protracted uncertainty depressing investment and slowing supply growth further.
  - Potential for tighter global financial conditions to raise corporate borrowing costs.

### Policy recommendations and priorities
- Fiscal policy:
  - Sustained fiscal consolidation would help restore fiscal buffers and prepare public finances for the expected increase in demographic-related spending.
  - Continued gradual consolidation is envisaged over the next three years.
- Monetary policy:
  - The pace of further tightening of the monetary policy stance should be gradual and data-dependent given high uncertainty about the future macroeconomic environment.
- Financial sector policy and supervision:
  - Continued focus on strict prudential supervision is warranted in the context of relatively easy financial conditions and Brexit-related risks.
  - Close collaboration with EU prudential authorities will be essential to maintain smooth functioning of the financial system and minimize risks.
- Structural reforms:
  - Structural reforms to boost productivity and facilitate reallocation of resources post-Brexit would help promote inclusive and sustainable growth.
- Contingency planning:
  - Given that a disorderly Brexit remains the largest risk, contingency planning and preparedness measures for a no-deal outcome are critical.

*Source: IMF staff report, United Kingdom, October 25, 2018.*

### 3.2 for details).

### UNITED KINGDOM

### Outlook and Productivity
- Productivity growth is projected to rise to about 1 percent (still well below pre-crisis levels).
- Some negative post-crisis factors (bank deleveraging and labor hoarding) have faded, which should support productivity growth.
- Investment in labor-saving technologies and the efficiency of labor utilization should also increase with the economy at full employment.

### Risks and Spillovers
- The most significant risk to the outlook is an exit from the EU without an agreement on the future relations.
  - Leaving the EU without an economic agreement, even in an orderly manner, or reaching an agreement with high barriers to trade in goods and services would lead to lower-than-projected medium-term growth.
  - A scenario in which future trade between the UK and the EU is governed by WTO rules is estimated to bring about output losses of around 5 to 8 percent compared to a no-Brexit scenario in the long run.
  - A worst-case scenario (a disorderly exit without an implementation period) could cause sharp falls in asset prices, hits to consumer and business confidence, sterling depreciation, higher domestic prices, disruptions in production and services, immediate trading on WTO terms with significant delays at borders, and severely restricted services trade.
  - An upside scenario: an agreement with fewer impediments to trade than assumed in the baseline could buoy confidence, activity, and asset prices; new trade arrangements with countries outside the EU could offset some losses over the long run.
- Other external or domestic risks:
  - Projected strengthening of labor productivity growth could fail to materialize due to weaker-than-projected investment growth and a decline in the number of skilled migrants.
  - Financing large current account deficit leaves the economy vulnerable to shifts in investors' preferences for UK assets; an abrupt reduction in net capital inflows would tighten domestic financial conditions and raise refinancing risks for leveraged firms and households.
  - High valuations of commercial real estate (CRE), and to a lesser extent housing, are additional sources of risk; CRE is widely used as collateral for corporate borrowing.
  - Households have reduced their savings since the referendum vote; a faster rebuilding of savings would help external accounts but depress consumption growth.
  - External risks include a deceleration of global growth, a global retreat from economic integration, a credit downturn in China, or stress in the euro area that could impact globally-exposed UK banks.
- Spillovers to EU and other economies:
  - A rise in trade barriers between the UK and the EU would imply losses for both sides; in a Free Trade agreement (FTA) scenario, the impact ranges from nearly zero to almost 3 percent of GDP for Ireland.

### Authorities’ Views on Outlook and Risks
- The authorities (Office for Budget Responsibility and the Bank of England) project growth to remain modest by historical standards, noting limited spare capacity and lower potential supply growth due in part to reduced net migration and subdued investment growth.
- A disorderly no-deal exit from the EU in March 2019 is the main downside risk to the outlook.
- The medium-term growth outlook depends on the outcome of Brexit negotiations and the recovery of productivity growth.

### External Assessment
- The current account deficit narrowed to 3.7 percent of GDP in 2017.
- Improvement in trade and primary income balances was driven by post-referendum currency depreciation and a stronger global economy.
- From a savings perspective, improvement reflects significant increases in savings by the government and private corporations, only partly offset by net dissaving by the household sector.
- From a financing perspective, the share of debt inflows has increased, which may be more vulnerable to refinancing risks.
- The current account deficit is projected to narrow further to about 3 percent over the medium term as import growth decelerates in line with subdued domestic demand.
- The currency composition of the UK's international investment position (IIP) mitigates some risks: the UK’s external assets have a higher foreign currency component than its external liabilities, so sterling depreciation increases the net IIP balance and improves net income (absent offsetting changes in gross investment flows).
- Persistent positive valuation effects have helped stabilize the net IIP over the last 20 years despite large cumulative current account deficits.
  - Bank of England estimates suggest that the net IIP based on market valuation was much higher, close to 80 percent of GDP in mid-2017 (November 2017 Inflation Report).
- Staff assessment: the current account gap was between 1 and 5 percentage points of GDP in 2017; the real exchange rate overvaluation in 2017 was in the range of 0 to 15 percent, with substantial uncertainty given unknown future trade arrangements.

### Policy Discussions and Recommendations
- Policies should focus on maintaining macroeconomic stability and boosting productivity.
  - Gradual steady reduction in public sector deficits and debt would help rebuild buffers, maintain investor confidence, and lower the current account deficit.
  - The pace of monetary tightening should be gradual and data-dependent given the high degree of uncertainty about the future macroeconomic environment.
  - Structural policies should focus on raising competitiveness and potential growth over the medium term.
  - Policies should facilitate the transition resulting from Brexit, supporting workers rather than particular jobs or sectors.
  - In the financial sector, continued prudent oversight is necessary to ensure resilience and prevent a relaxation of credit standards.
  - Contingency plans are important to maintain economic and financial stability in case of a disorderly exit from the EU.
- UK government preparatory actions for Brexit:
  - Parliament passed legislation converting EU laws into UK law.
  - Government guaranteed EU program funding committed to projects in the UK before the end of 2020.
  - A budgetary allocation of £3 billion has been established to help fund the costs of Brexit preparation.
  - Thousands of civil servants have been hired to help shoulder the workload.
  - Technical notices have been published to help private stakeholders prepare for a no deal scenario.
  - Government committed to providing temporary permissions for EU financial institutions to continue to operate in the UK at the moment of departure.
- However, many preparatory tasks require greater clarity on the future trade relationship; risks of serious disruptions exist without an implementation period. Continued close cooperation between UK and EU authorities across policy areas would be mutually beneficial.

### Monetary Policy
- Monetary stance and actions:
  - Monetary policy remains accommodative despite a cumulative 50 basis point increase in Bank Rate over the last 12 months.
  - The Bank of England raised the policy rate by 25 basis point to 0.75 percent in August.
  - The nominal policy rate is still below Fund staff’s estimated neutral rate of about 1½ percent.
  - The MPC voted to maintain the stock of gilts and corporate bonds on the Bank’s balance sheet.
  - A Term Funding Scheme (TFS) for banks was closed at the end of February 2018; a total of £127 billion was drawn and banks must repay the funds within four years.
- Inflation and labor costs:
  - Import price inflation has declined in recent months as the impact of past sterling depreciation on prices is fading.
  - The unemployment rate is historically low despite record high labor force participation.
  - Private sector pay growth has strengthened; productivity growth remains modest.
  - Unit labor costs increased by about 2½ percent yoy in the first half of 2018 and are projected to remain relatively high in the near term.
  - High energy prices are expected to keep headline inflation above 2 percent for the rest of 2018, with a gradual convergence to target projected next year.
- Policy guidance:
  - A modest further tightening of monetary policy over the next two years would likely be needed to ensure that inflation converges sustainably to the target if excess demand pressures persist after domestic inflation reaches a level consistent with the 2-percent target.
  - Policymakers should remain ready to respond flexibly to data developments in an environment of greater-than-usual uncertainty; accommodative conditions should be maintained longer if negative Brexit-related surprises depress domestic demand.
  - Transparent and timely communication is important to guide market expectations.
- Bank of England balance sheet strategy:
  - The Bank intends to continue to use Bank Rate as the main policy instrument.
  - The MPC announced it does not intend to start reducing the stock of purchased assets until Bank Rate reaches around 1.5 percent.
  - Staff agreed with this strategy and that the Bank should start reducing its balance sheet in a gradual and predictable manner when appropriate.
  - The Bank expects to continue using a floor system to control short-term interest rates; long-run central bank balance sheet size will depend on demand for reserves and would likely be higher than pre-crisis due in part to liquidity regulation changes.
  - Asset sales may need coordination with the UK Debt Management Office to minimize impact on market liquidity conditions; the Bank will need to monitor short-term money markets to determine the equilibrium value of the balance sheet.
  - A clear communication of the Bank’s approach to asset sales and the indicators it will use to determine the end-point for normalization would help guide the market.
- Institutional framework:
  - The new Bank of England capital framework establishes a rules-based framework to define the Bank’s capital needs and its income distribution policy.
  - The framework provides adequate financial resources to ensure the Bank’s independence and back its monetary policy and financial stability mandates.

*Source: IMF staff report (selected excerpts).*

### 23. The authorities reiterated that future increases in the Bank Rate are likely to be

### 23. The authorities reiterated that future increases in the Bank Rate are likely to be

### Monetary policy and Bank Rate outlook
- The authorities reiterated that future increases in the Bank Rate are likely to be gradual and limited.
- The authorities expect domestic cost pressures will keep rising as labor market pressures feed into higher wages.
- Indicators of rising wage pressures were noted, including strong pay growth for recently hired workers.
- The effect of Brexit on monetary policy is difficult to predict; exit could be accompanied by significant supply shocks whose impact could dominate those of lower demand.
- The authorities agreed that the balance sheet should be reduced in a predictable and well-communicated manner.
- Note on threshold change: The lowering of this threshold from 2 to 1.5 percent was justified by an updated assessment of the effective zero lower bound for the policy rate. With new facilities such as the Term Funding Scheme, commercial banks can get funding at the Bank Rate.

*Italic: Source: cr18316 - 23. The authorities reiterated that future increases in the Bank Rate are likely to be — IMF staff content unit.*

### 35. Banks’ balance sheets have continued to strengthen. Capital and liquidity coverage ratios

### 35. Banks’ balance sheets have continued to strengthen. Capital and liquidity coverage ratios

### Banks' balance-sheet strength and profitability
- Authorities raised the countercyclical capital buffer requirement from 0.5 to 1 (effective as of November 2018), reflecting an assessment of a “standard risk environment” apart from Brexit-related risks.
- The 2017 annual stress test conducted by the BoE suggests the UK banking system would be resilient to deep simultaneous recessions in the UK and major economies, large falls in asset prices (including house prices), and further misconduct costs.
- All banks subject to the ringfencing requirements are on track to meet the January 2019 deadline, which should further strengthen the bank resolution framework.
- Profitability remains a challenge:
  - Persistently low profitability hinders banks’ ability to accumulate capital from retained earnings following an adverse shock.
  - Profitability should improve over the medium term as legacy misconduct costs dwindle and banks continue to adjust their business models.
  - Rising interest rates should help alleviate the pressure on interest margins.

### Financial Soundness Indicators for Major UK Banks (Percent) — Selected figures and indicators
- The presentation of IMF/BoE indicators as provided:
  - "Financial Soundness Indicators for Major UK Banks 1/ (Percent)"
  - "Foreign investors accounted for 50 percent of transactions in UK CRE in 2018 Q2."
- Capital adequacy (as presented):
  - "Basel III common equity Tier 1 capital ratio...   7.28.410.011.412.613.414.6"
  - "Simple leverage ratio4.8   5.15.15.65.96.66.66.9"
  - "Basel III leverage ratio (2014 proposal)...   .........4.44.94.95.0"
- Asset quality (as presented):
  - "Non-performing loans net of provisions to capital...   16.113.99.55.43.93.43.4"
  - "Non-performing loans to total gross loans...   4.03.63.11.71.00.90.8"
- Profitability (as presented):
  - "Return on assets before tax1.1   0.40.20.30.50.40.30.6"
  - "Price-to-book ratio224.3   58.782.7107.499.589.281.097.0"
- Liquidity (as presented):
  - "Loan-to-deposit ratio113.1  108.9    103.199.195.997.194.093.9"
  - "Short-term wholesale funding ratio...   19.116.714.713.610.510.111.9"
  - "Average senior CDS spread...   2.71.51.00.60.80.90.3"
- Footnote summarizing coverage and data vintage:
  - "1/ The coverage of banks is as defined in the Bank of England's December Financial Stability Report, except for asset quality indicators, for which the coverage is as defined in the IMF's Financial Soundness Indicators. Data for 2017Q3 or latest available. Sources: Bank of England FPC Core Indicators; IMF Financial Soundness Indicators."

### Supervision, regulatory policy, and monitoring recommendations
- Continue a prudent approach to supervision to maintain financial stability.
- Keep the CCyB rate under review to ensure it reflects shifts in the overall risk level.
- Timely adoption of the Basel III final agreement and implementation of Bank of England’s guidance on the use of hybrid models for estimating risk weights should help reduce risk-weight variability among banks.
- Continue adjusting bank-specific capital buffers to match individual banks’ risk exposures.
- Closely monitor potential risks related to market-based finance:
  - Authorities are collecting information on leverage outside the banking system to assess potential vulnerabilities.
  - The BoE is developing a system-wide stress simulation covering hedge funds, dealers, insurance companies and other non-bank firms to assess contagion risks and institutions’ ability to deal with sharp rises in redemptions during high asset price volatility.
- Continue efforts to actively monitor and mitigate cyber security risks.

### Authorities’ views on prudential policy and Brexit-related preparedness
- Authorities are committed to implementing prudential and regulatory policies after Brexit that meet or exceed international standards, independent of the outcome of EU withdrawal negotiations.
- Contingency planning in the financial sector is advancing:
  - The temporary permission regime (awaiting parliamentary ratification) and other legislation would allow EEA financial firms operating in the UK via a passport to continue regulated activities for up to three years after exit.
  - Authorities stressed the risk that cross-border derivative and insurance contracts could be affected by the loss of passporting rights absent an analogous temporary permissions regime on the EU side.
- The Bank of England noted domestic banks' capital ratios have tripled since the end of 2007 and are at an adequate level to withstand a range of shocks, including those associated with a disorderly Brexit.
- Macroprudential requirements on mortgage lending implemented in 2014 should mitigate risks from high household leverage.
- Ringfencing of banks would help ensure banks can be resolved without resorting to public funds.
- Adoption of the MiFID II framework has helped strengthen investor protection and transparency.

### Contingency planning for a disorderly no-deal Brexit
- Adequate capitalization, temporary permissions, and ensuring liquidity provision could help mitigate financial disruptions from a potential disorderly Brexit.
- The planned temporary permission regime for financial institutions would reduce the risk of financial services disruption for UK customers.
- In the event of stress in financial markets, the BoE will need to ensure the financial system has adequate liquidity.
- The countercyclical buffer could be released to support bank credit supply, provided any relaxation maintains confidence and resilience against future shocks.
- The 2018 annual stress test should be used to gauge the banking system’s strength to withstand Brexit-associated risks.

### Fiscal and monetary policy considerations for Brexit shocks
- Fiscal space:
  - There is some fiscal space to help smooth adjustment if needed.
  - The UK faces limited financing risks in the near term despite a relatively high debt burden.
  - Gross financing needs over the forecast horizon are manageable under both the baseline and stress simulations.
  - Market-implied default probabilities remain contained and sovereign yields are low from a historical perspective.
  - Automatic stabilizers should be allowed to operate freely.
  - Additional expenditure on labor market policies (retraining, relocation support) could be warranted.
  - Specific measures that could be used include frontloading infrastructure spending to raise productive capacity.
  - Any policy easing should be temporary and anchored in credible medium-term fiscal consolidation plans because a permanent decline in output would require eventual fiscal adjustment.
- Monetary policy:
  - Appropriate response depends on relative shifts of supply and demand, change in the exchange rate, and stability of inflation expectations.
  - Consumer prices are likely to increase as trade costs rise and sterling depreciates; output would decline and structural unemployment may increase.
  - Authorities may face a trade-off between inflation and output stabilization; natural tightening of financial conditions due to heightened investor risk aversion must be considered.
  - Authorities believe the Bank of England has enough instruments to ensure adequate system liquidity.

### Structural reforms and medium-term growth priorities
- Sustained policy efforts are needed to support growth, improve competitiveness, and reduce income inequality and regional disparities.
- Key near-term reform priority: strengthening human capital, including retraining to support adjustment to Brexit-related structural changes.
- Specific reform areas and recommendations:
  - Housing supply: boost housing supply by easing planning restrictions and reforming property taxes to encourage efficient use of housing stock.
  - Infrastructure: increase public investment; close infrastructure gap with peer economies; strengthen institutional framework for project selection and oversight.
  - Human capital: monitor and evaluate T-level technical qualifications and apprenticeship funding reforms; recent initiatives to increase basic skills of high-school graduates could reduce inequality and foster mobility.
  - Research and development: public and private R&D spending is relatively low; government pledge to increase public investment in R&D programs is a step in the right direction.
  - Decentralization: greater role for local decision-making could better tailor policies to local conditions if equalization mechanisms ensure subnational resources.
- Gender and labor-market participation:
  - Female participation rate is 74 percent.
  - Fully closing the participation rate gap would boost output by around 5 to 6 percent in the long run.
  - Gender pay gap stands at 10 percent on average for full-time employees.
  - Policies to facilitate job sharing, compressed work schedules, and increased female representation in senior positions and corporate boards are recommended.
  - Legislation requiring larger firms to publish gender pay gap data has helped focus attention.

### Corporate transparency and anti-corruption efforts
- Corporate transparency continues improving:
  - Measures to verify beneficial ownership information in the publicly available People with Significant Control (PSC) register are being developed and implemented.
  - Financial institutions will be required to report discrepancies in the PSC register.
  - Strong enforcement actions for breaches of PSC and private trust register requirements will help ensure timely and accurate information.
  - Proposal for a register of overseas legal entities owning UK real estate is welcome and should include verification measures.
  - The Office for Professional Body Anti-Money Laundering Supervision is expected to improve consistency of AML supervision in the accounting and legal sectors, especially for firms providing trust and company services.
  - UK authorities’ commitment to supporting British Overseas Territories (BOTs) in establishing public registers of beneficial ownership of companies is welcome.
  - Agreements allowing rapid exchange of information for companies registered in Crown Dependencies and BOTs should be extended to cover trusts.

*Source: cr18316 - 35. Banks’ balance sheets have continued to strengthen. Capital and liquidity coverage ratios (PDF chapter).*

### 47. Anti-foreign bribery enforcement has strengthened in recent years. The report by the

### Anti-foreign bribery enforcement has strengthened in recent years. The report by the

### Recent enforcement developments and findings
- The OECD Working Group on Bribery in International Business Transactions commends the UK’s enforcement efforts and political commitment to fighting foreign bribery.
- Positive assessment due to legislative reforms, such as deferred prosecution agreements, and the effective approach taken by the Serious Fraud Office (SFO) to investigate and resolve cases.
- Channels for whistleblowing and detection capabilities were improved, including through enhanced intelligence analysis by the SFO.
- Individuals and companies have been found criminally liable, civil remedies have been applied and administrative sanctions imposed.
- Footnotes in source:
  - 26: In the case of the UK, the assessment is based on the OECD Working Group on Bribery in International Business Transaction’s Phase 4 report published in March 2017. The information contained herein does not prejudice the Working Group’s monitoring of the implementation of the OECD Anti-Bribery Convention.
  - 27: A progress report by the OECD Working Group is expected to be published in March 2019. The discussion on whether the UK has an effective AML/CFT system designed to prevent foreign officials from concealing the proceeds of corruption will be included in a future Article IV consultation staff report when the FATF fourth round report for the UK is completed.

### OECD Working Group recommendations (areas of focus)
- (i) maintaining the role of the SFO in foreign bribery cases;
- (ii) further improving interagency cooperation and ensuring the safeguard of the independence of investigations and prosecutions;
- (iii) improving coordination of law enforcement between England, Wales, and Scotland and improving Scotland’s enforcement capacity;
- (iv) enhancing the UK’s AML reporting framework to improve detection of foreign bribery;
- (v) strengthening engagement with the CDBOT regarding the detection and enforcement; and
- (vi) conducting a comprehensive review of Her Majesty’s Revenues and Customs capacity to detect and report foreign bribery.
- Fund staff agrees with these recommendations and urges the UK to move forward to implement them.

### Authorities’ views and actions
- Authorities welcomed the IMF assessment of efforts to tackle issues related to beneficial ownership and the supply side of corruption.
- Developments cited by authorities:
  - Progress on the PSC and private trust registers.
  - Public consultation for the register of overseas legal entities owning UK real estate.
  - Beneficial ownership information is now a condition of awarding contracts that involve central government procurement and meet certain criteria or thresholds.
  - Implementation of OECD Phase 4 recommendations.
  - Increased budget of the SFO.
  - Creation of a new National Economic Crime Centre to improve cross-government intelligence sharing and cooperation.

### Staff appraisal — macroeconomic context and outlook
- Economic activity has moderated since the referendum in June 2016.
- Net exports were supported by weaker sterling and strong external demand.
- Above-target inflation following the sharp post-referendum depreciation reduced real income and consumption growth.
- Business investment has been lower than would be expected in the context of robust global growth and favorable financing conditions.
- Despite the slowdown in growth, the employment rate has risen to a record high and slack in the economy is limited.
- Growth is expected to remain moderate in the near term, although there are significant risks.
  - Investment would remain constrained as long as Brexit uncertainty weighs on firms.
  - With the economy operating at full employment and household saving already at a very low rate, consumption growth will be broadly in line with subdued real income growth.
  - Net exports are expected to continue to make a positive contribution to growth.
- Baseline forecast conditional on a timely agreement with the EU including on a trade pact covering goods and some services, and a relatively smooth Brexit process thereafter.
- Leaving the EU without an agreement is identified as the most significant near-term risk to the UK economy; a disruptive departure without an implementation period could have serious negative economic consequences.

### Monetary and fiscal policy guidance
- Monetary policy:
  - Should respond flexibly to data developments in an environment of heightened uncertainty.
  - If domestic inflation surpasses the level consistent with the 2-percent target, further gradual tightening of monetary policy would be warranted.
  - If negative economic shocks depress domestic demand relative to supply, accommodative conditions should be maintained.
  - The reduction in the Bank of England’s balance sheet should commence once the policy rate has reached a level from which it can be cut materially in the event of a demand slowdown.
- Fiscal policy:
  - Steady fiscal consolidation remains critical to comply with the government’s fiscal framework, build buffers against future shocks, and help reduce the current account deficit.
  - The recently-announced increase in public health spending should be financed from new revenue sources and/or offsetting spending cuts elsewhere in the budget.
  - Brexit-related effects would add to the rising strain on public finances related to population aging.
  - To mitigate age-related spending increases, the authorities should explore opportunities for further efficiency gains in health care provision and eliminate the “triple lock” on public pensions.
  - Absent a fundamental rethinking of the size and role of the public sector, revenue measures would need to occupy a more prominent place in deficit reduction efforts going forward.

### Financial stability and supervision
- Continued prudent approach to supervision is crucial amid relatively easy financing conditions and heightened Brexit-related risks.
- Household and corporate leverage have started to edge up, although they remain below pre-crisis levels.
- Consumer credit continues to rise faster than income, despite recent tightening of underwriting standards.
- Further policy action may be needed if high rates of growth persist, including additional increases in bank-specific capital buffers and steps to enhance the oversight of nonbank financial institutions.
- Regulatory and supervisory cooperation between UK and EU authorities will be crucial to maintaining the integrity of cross-border financial transactions after Brexit.
- EU and UK authorities should work together to ensure legal continuity in insurance and derivative contracts and proper data sharing to avoid cliff-edge effects.
- Continued commitment to high regulatory standards is essential to preserve hard-won financial stability gains.
- In a disorderly no-deal Brexit scenario, policies should seek to safeguard macroeconomic and financial stability:
  - Bank of England would need to ensure that the financial system has adequate liquidity in the event of financial market disruption accompanied by sharp declines in asset prices.
  - Fiscal framework provides flexibility to support the economy, for example through bringing forward infrastructure spending, but the space to respond could narrow if the shock were to significantly raise interest rates on public debt.
  - Any easing of fiscal policy should be targeted and embedded in a credible medium-term fiscal consolidation plan.
  - A permanent shock to output would require an eventual adjustment of revenues or spending.

### Structural and inclusiveness policies
- Further sustained policy efforts needed to support productivity and make growth more inclusive.
- The plan to increase public infrastructure investment over the medium term is welcome.
- Continued focus on policies to increase human capital is critical.
- Improving economic opportunities for women by facilitating flexible work arrangements and closing the gender pay gap would promote growth and equity.
- Brexit will lead to important shifts in the structure of the UK economy and policies could play a role in facilitating the transition.
- Policies should seek to support workers and not particular jobs or sectors. Options include:
  - Support for re-training;
  - Policies that promote entrepreneurship;
  - Higher investment in research and development;
  - Reforms to promote housing supply and mobility.

### Corporate transparency and anti-corruption follow-up
- Efforts to improve corporate transparency and enforcement against foreign bribery should continue.
- Measures to verify beneficial ownership continue to be developed and implemented.
- Ensuring consistent and effective AML supervision of TCSPs is critical to mitigating ML abuse.
- Enhancing continued exchange of information on companies and trusts with the CDBOT is important.
- Efforts to combat the supply side of corruption are welcome, and further enforcement including in CDBOT is encouraged.

*International Monetary Fund — United Kingdom staff report excerpt*

### 59. It is recommended that the next Article IV consultation be held on the standard

### cr18316 - 59. It is recommended that the next Article IV consultation be held on the standard

### Recommendation
- It is recommended that the next Article IV consultation be held on the standard 12-month cycle.

### Recent macroeconomic and inflation developments
- "Inflation has begun to fall since November... as the effect from past sterling depreciation fades."
- "Projected increase in oil prices is expected to raise headline inflation over the near term."
- "Inflation expectations remain in line with the target."
- Key inflation measures and references in charts:
  - Core CPI and CPI (Percent change, yoy) — chart reference: Sep-2018.
  - CPI Components: Nonenergy Industrial Goods and Services; NEER, rhs — chart reference: Sep-2018.
  - Inflation Expectations: "2-year ahead", "5-year ahead", "average over 2005-18", "5-year ahead 5 year inflation expectations" (Percent) — chart reference: Sep-2018.

### Labor market developments
- "Wage growth has picked up since 2017Q3... supporting a moderaterising unit labor cost."
- "Unemployment rate is at ahistoric low level, but average hours worked has fallen recently ..."
- "More recently, UK born workers have been the main contributor to employment growth."
- "The improvement in job-to-job flow rate has stalled... as well as the share of PT workers who want a full time job."
- "The growth of the labor force is slowing: net work-related migration has declined in recent quarters."
- Labor market datapoints and references:
  - Employment Growth and Unemployment Rate (Percent) — 2018:Q2.
  - Job-to-job Flow Rate (Percent of workers remaining in employment) — 2018Q2.
  - Labor Force Participation Rate (Percent working age population, 4q moving average) — 2018:Q2.
  - Share of Part-time Workers Who Could not Find Full-time Job (Percent of part-time workers) — 2018Q2.
  - Contributions to Employment Growth (percent) — period: 2016Q3 - 2018Q2.
  - Work Related Migration (Thousands) — 2018Q1; chart shows Inflow, Outflow, Net inflow, rhs.

### External sector
- "The current account deficit was financed by debt inflows in 2017."
- "The recent sterling depreciation helped improve UK’s net international investment position (NIIP)."
- "...with primary income balance benefiting from sterling depreciation post-referendum."
- "Returns on foreign direct investment have increased."
- "The current account has improved in 2017..."
- From S-I perspective, "household sector savings have continued to decline." — 2018:Q2.
- Key external-sector datapoints:
  - Primary Income Balance (Percent of UK GDP) — series 2001–2017.
  - NIIP (percent of GDP) and NEER/REER indices — 2018:Q2.
  - Net Primary Income Balance (Percent of GDP) — 2017 decomposition includes Earnings on FDI, Equity Securities, Debt Securities, Other Investment in UK, Reserve Asset, Compensation of Employees, Balance.
  - Saving-Investment Balance, by Sectors (Percent of GDP) — 2000–2017: Private NFC, FC, Government, Public NFC, Household.
  - Financing the Current Account (Percent of GDP) — 2017: FDI, Equity, Debt, Derivatives, Reserve, FA, rhs.
  - Current Account Balance (Percent of GDP) — 2000–2016.

### Fiscal developments and public finances
- "Fiscal consolidation has continued, with the deficit falling below 2 percent of GDP in FY17."
- "Authorities envisage a slower pace of consolidation ahead, due to weaker growth prospects ... and more gradual structural adjustment."
- "The debt ratio is expected to start falling after FY17."
- "The consolidation so far has been mainly driven by expenditure measures... and more spending cuts are planned ahead."
- Fiscal datapoints and projections:
  - Public Sector Net Borrowing (Percent of GDP) — FY10–FY17 series.
  - Fiscal Consolidation Plan (Percent of GDP) — FY16–FY20 (Net borrowing (2016 March Budget); Net borrowing (2018 Update)).
  - Net Public Sector Debt (Percent of GDP) — FY10–FY20: PSND; PSND excl. BoE.
  - Public Sector Discretionary Consolidation Plan (Percent of average FY2010-FY2015 GDP) — Revenue and Spending.
  - Public Sector Spending (Percent of GDP) — FY10–FY20.
  - Cyclically-Adjusted Primary Balance (Percent of potential GDP) — FY14–FY20 comparisons: 2018 Update vs March 2016 Budget.
  - Note: "English housing associations are re-classified from the public to the private sector starting in FY2017. They contribute 0.2 and 3.3 percent of GDP to net borrowing and net debt, respectively."

### Non-financial corporate health
- Indicators show corporate leverage and profitability across firm sizes:
  - Total Debt to Equity (Median; in percent) — series 2007–2017 for "All firms", "Large firms", "All firms w. data for 2017".
  - Return on Assets (Median; in percent) — series 2007–2017.
  - Interest Coverage Ratio (Median; in units) — series 2007–2017.
  - Corporate Expected Default Frequency (Median 1y EDF; in percent) — Jul-07 to Jul-17, country comparisons: UK, France, Germany, Netherlands.

### Credit market developments
- "The borrowing costs of non-financial corporates (NFCs) have increased somehow but remain low."
- "Mortgage lending rates have continued to fall."
- "Bank credit growth to NFCs turned positive in 2016."
- "Mortgage credit is growing in line with income, while consumer credit continues to grow at a fast pace."
- "Credit conditions remain broadly supportive, despite some recent tightening of consumer credit conditions."
- "Market funding has weakened in recent quarters."
- Key credit datapoints (preserved labels and dates):
  - Household Lending Rates (Percent) — Aug-18: Consumer credit, Mortgages.
  - Lending Rates to Private NFCs (Percent) — Aug-18: Bank lending rates to private NFCs; Corporate bond yields (investment grade); Corporate bond yields (high yields, rhs).
  - Household Credit Growth (Percent) — Aug-18: Mortgages, Consumer credit.
  - Bank and Building Society Lending to UK Firms (y/y percent change) — Aug-18.
  - Bank of England Survey: Credit Availability over Past 3 Months (Net percentage balances 1/) — 2018Q2; >0 indicates that more credit is available.
  - UK: Net Finance Raised by UK Businesses (Bn. sterling, SA) — Aug-2018: Loans, Commercial paper, Bonds, Equity.

### Housing market developments
- "The share of highly indebted households remains low."
- "Lending to the buy-to-let market has continued to grow at a slow pace over the last year... after a period of deleveraging."
- "Prices remain high relative to income, reflecting supply constraints."
- "The low interest rates have kept mortgage payments affordable. However, household debt is starting to rise..."
- "House prices have moderated, especially in London."
- Housing datapoints and references:
  - Real House Prices (2008:1=100) — UK and London — 2018Q2.
  - House Price-to-income Ratios (Percent) — UK and London — 2016Q3 and 2018Q2.
  - Debt Ratios (Percent) — Debt to total assets; Debt to housing assets, rhs 1/ — 2017. (Note 1/: Housing assets for 2016 and 2017 are derivated using house prices.)
  - Household Debt and Debt Servicing Ratios (Percent of disposable income) — 2017Q4: HH debt-to-income; Debt servicing ratios, rhs.
  - Loan-to-income and Loan-to-value Ratios (Percent of new mortgage lending) — 2018Q2: LTI above 4; LTV over 75%, rhs; LTI above 3 (joint, rhs).
  - Outstanding Mortgage Balances (Percent of GDP) — 2018Q2: Mortgages; Buy-to-let, rhs.

### Inequality
- "UK income inequality is high relative to other advanced economies... although it has declined since the crisis."
- "The progressive tax system helps reduce inequality ... however, intergenerational income elasticity is low."
- Inequality datapoints and references:
  - Net Gini Index (2017) 1/ and UK Net Gini Index (1961–2015) 2/ (sources: OECD; SWIID; Corak (2015)).
  - Market and Net Inequality by Country (0-100 scale) — includes Gini of net income and Gini of gross income for multiple countries.
  - Inequality and Intergenerational Income Elasticity 3/ — chart shows Gini index vs Intergenerational income elasticity; note: Intergenerational income elasticity defined as percentage difference in adult earnings of a son/daughter for each one percentage point increase in parents’ earnings.

### Migration
- "The employment rate of foreign-born residents is high in the UK relative to other OECD countries ... in part due to their high education level."
- "Some sectors rely heavily on EU workers."
- "Net migration is projected to remain a key contributor to the future growth of UK’s working-age population."
- "Over the last 16 years there has been no evidence of employment displacing native-borns."
- "Both EU and non-EU migration have declined since the referendum."
- Migration datapoints:
  - Long-Term International Migration into and out of the UK (Thousands) — Mar-18; series for EU and non-EU immigration and emigration.
  - Foreign-born Employment (Percent of foreign-born population, 2016).
  - Education Status (Percent of working age population, age finished, 2015) — UK Born, EU immigrants, A8 immigrant, All immigrants; High (21+), Medium (17-20), Low (<16).
  - Share of Workers in Industry Who Were Born in EU 1/ (Percent of sector's workforce, 2015).
  - Employment Rate (Percent) — 2017: native-born and foreign-born series.
  - Population Projection (Million) — ONS baseline projection 2/ vs Zero net migration for 2016–2031.

### Key economic indicators (selected)
- Real GDP (change in percent): 2014: 2.9; 2015: 2.3; 2016: 1.8; 2017: 1.7; 2018: 1.4; 2019: 1.5.
- Private final domestic demand (change in percent): 2014: 2.9; 2015: 2.8; 2016: 3.0; 2017: 2.1; 2018: 1.1; 2019: 1.4.
- CPI, end-period (percent): 2014: 1.0; 2015: 0.1; 2016: 1.2; 2017: 3.0; 2018: 2.3; 2019: 2.1.
- Unemployment rate (in percent) 2/: 2014: 6.2; 2015: 5.4; 2016: 4.9; 2017: 4.4; 2018: 4.1; 2019: 4.2.
- Gross national saving (percent of GDP): 2014: 12.3; 2015: 12.3; 2016: 12.0; 2017: 13.6; 2018: 13.7; 2019: 14.0.
- Public sector overall balance (fiscal year, percent of GDP) 3/: 2014: -4.9; 2015: -3.8; 2016: -2.3; 2017: -1.9; 2018: -1.9; 2019: -1.5.
- Public sector cyclically adjusted primary balance (staff estimates) 4/: 2014: -2.7; 2015: -2.0; 2016: -0.6; 2017: -0.1; 2018: -0.3; 2019: 0.0.
- Public sector net debt (percent of GDP): 2014: 82.6; 2015: 82.3; 2016: 85.2; 2017: 85.3; 2018: 85.5; 2019: 84.7.
- Current account balance (percent of GDP): 2014: -4.9; 2015: -4.9; 2016: -5.2; 2017: -3.8; 2018: -3.5; 2019: -3.2.
- Exchange rate (Bilateral rate, October 5, 2018): US$1 = £0.7832.
- Nominal effective rate (2010=100, year average) 5/: 2014: 114.2; 2015: 101.8; 2016: 95.9; 2017: 95.5 (note: as of September 2018 for NEER/REER references).

### Medium-term scenario and projections (selected)
- Real GDP (percent change): 2018: 1.4; 2019: 1.5; 2020: 1.5; 2021: 1.6; 2022: 1.6; 2023: 1.6.
- Q4/Q4 real GDP (percent change): 2018: 1.4; 2019: 1.5; 2020: 1.5; 2021: 1.6; 2022: 1.6; 2023: 1.6.
- Gross national saving (percent of GDP): 2018: 13.7; 2019: 14.0; 2020: 14.4; 2021: 14.6; 2022: 14.8; 2023: 15.1.
- Gross domestic investment (percent of GDP): 2018: 17.2; 2019: 17.2; 2020: 17.2; 2021: 17.5; 2022: 17.6; 2023: 17.9.
- Current account (percent of GDP): 2018: -3.5; 2019: -3.2; 2020: -3.0; 2021: -3.0; 2022: -2.9; 2023: -2.9.
- CPI Inflation, period average: 2018: 2.7; 2019: 2.5; 2020: 2.2; 2021: 2.0; 2022: 2.0; 2023: 2.0.
- CPI Inflation, end period: 2018: 2.3; 2019: 2.1; 2020: 2.0; 2021: 2.0; 2022: 2.0; 2023: 2.0.
- Unemployment rate (percent of labor force, period average): 2018: 4.1; 2019: 4.2; 2020: 4.5; 2021: 4.5; 2022: 4.5; 2023: 4.5.
- Potential output growth (percent): 2018: 1.4; 2019: 1.4; 2020: 1.5; 2021: 1.6; 2022: 1.6; 2023: 1.6.
- Memorandum items:
  - Household saving rate 7/: 2018: 4.4; 2019: 4.3; 2020: 4.2; 2021: 4.2; 2022: 4.1; 2023: 4.2.
  - GDP per capita growth: 2018: 0.7; 2019: 0.9; 2020: 1.0; 2021: 1.1; 2022: 1.2; 2023: 1.2.

### Public sector operations (selected staff projections)
- Revenue (percent of GDP): 2017/18: 36.6; 2018/19: 36.7; 2019/20: 36.8; 2020/21: 36.8; 2021/22: 36.7; 2022/23: 36.7.
- Expenditure (percent of GDP): 2017/18: 38.8; 2018/19: 38.4; 2019/20: 38.3; 2020/21: 38.1; 2021/22: 37.8; 2022/23: 37.6.
- Net lending/borrowing (overall balance, percent of GDP): 2017/18: -2.2; 2018/19: -1.8; 2019/20: -1.6; 2020/21: -1.3; 2021/22: -1.1; 2022/23: -0.9.
- Cyclically adjusted primary balance (CAPB, percent of potential GDP): 2017/18: -0.5; 2018/19: -0.3; 2019/20: -0.1; 2020/21: 0.2; 2021/22: 0.3; 2022/23: 0.6.
- General government gross debt (Maastricht basis, percent of GDP): 2017/18: 85.5; 2018/19: 85.4; 2019/20: 85.3; 2020/21: 84.9; 2021/22: 84.8; 2022/23: 84.2.
- Public sector net debt (end of fiscal year using centered-GDP as denominator): 2017/18: 85.6; 2018/19: 85.5; 2019/20: 85.1; 2020/21: 82.1; 2021/22: 78.3; 2022/23: 77.9.

### Balance of payments and net investment position (selected projections)
- Current account (percent of GDP): 2018: -3.5; 2019: -3.2; 2020: -3.0; 2021: -3.0; 2022: -2.9; 2023: -2.9.
- Net investment position (percent of GDP): 2018: -11.5; 2019: -14.4; 2020: -17.1; 2021: -19.6; 2022: -21.9; 2023: -24.1.
- Assets (percent of GDP): 2018: 518.1; 2019: 509.7; 2020: 501.6; 2021: 493.3; 2022: 484.9; 2023: 477.1.
- Liabilities (percent of GDP): 2018: 529.6; 2019: 524.1; 2020: 518.7; 2021: 512.9; 2022: 506.8; 2023: 501.2.

*Source: IMF staff and figures, tables, and notes as presented in the content unit.*

### Annex I. External Sector Assessment

### Annex I. External Sector Assessment

### Overall Assessment
- The external position in 2017 was weaker than implied by medium-term fundamentals and desirable policy settings, and preliminary data suggest the assessment will be broadly unchanged for 2018.
- Background: The net international investment position (NIIP) declined from -2.4 percent of GDP in 2016 to -8.6 percent of GDP in 2017. Over the past five years, the NIIP has strengthened by 20.4 percentage points, reflecting a negative CA contribution (-22.4pp) more than offset by valuation and growth effects (37.9pp and 4.8 pp respectively).
- Staff projects the NIIP to weaken over the medium term, although the importance of and uncertainty around valuation effects cast significant doubt around these estimates.
- Assessment:
  - The sustainability of NIIP is not a concern.
  - Since 2000, valuation gains have offset around a third of the effect of current account flows on the IIP.
  - UK’s external assets have a higher foreign-currency component than its external liabilities, so the NIIP improves with sterling depreciation.
  - Fluctuations in the underlying gross positions are a potential source of vulnerability (excluding derivatives, gross assets and gross liabilities exceed 400 percent of GDP).
- Potential policy responses:
  - The current fiscal consolidation plan implemented within a medium-term framework will appropriately continue to support the external rebalancing.
  - Structural reforms focused on broadening the skill base and investing in public infrastructure should boost productivity, improving the competitiveness of the economy.
  - Maintaining financial stability through macroprudential policies should also support private-sector saving.
  - These efforts are particularly important in light of expectations that access to the EU market will become more restrictive.
- Uncertainty: The uncertainty around this assessment is significant, reflecting both possible measurement uncertainty, as well as uncertainty about the future trade arrangement with the EU and its possible effect on growth and trade flows.

### Current account
- Background:
  - The CA balance improved to -3.9 percent of GDP in 2017 (from -5.2 percent in 2016) and is expected to further improve to -3.5 percent of GDP in 2018, remaining significantly below its average historical values.
  - The wider CA deficits since the global financial crisis reflect mostly weaker income balance, due in part to lower earnings on the UK’s foreign direct investment abroad (especially in the euro area).
  - The trade balance has been broadly stable at around -1.6 percent of GDP through 2016, and increased to -1.1 percent in 2017, supported by strong growth in trading partners and a weaker sterling. It is expected to remain broadly stable in 2018, at -1.0 percent of GDP.
  - The CA improvement in 2017 was also driven by an improvement in net income flows (0.9 percent of GDP), helped by the positive valuation effect from sterling depreciation which increase the sterling value of income inflows denominated in foreign currency.
  - From a savings-investment perspective, the CA dynamics during 2017 reflect an improvement in gross national savings, but the CA deficit reflects a still elevated general government deficit (1.8 percent of GDP in 2017) and low private sector savings.
- Assessment:
  - The EBA CA model estimates a CA gap of -4.8 percent of GDP for 2017 (a cyclically-adjusted CA balance of -3.8 percent of GDP compared with a CA norm of 1 percent of GDP).
  - The cyclically-adjusted CA could be understated due to measurement biases associated with large NIIP valuation effects.
  - Looking ahead, the recovery of global growth relative to UK growth should translate into higher net income inflows over time.
  - Uncertainty around the CA gap estimation is high, as evident from the results under different methodologies, partly reflecting measurement uncertainties (large and volatile NIIP valuation changes, and other unidentified stock-flow adjustments).
  - Overall, staff assesses the 2017 cyclically-adjusted CA balance to be 1 to 5 percent of GDP weaker than the CA norm, with a mid-point of 3 percent of GDP. This range takes into account the uncertainty in the assessment due to the Brexit negotiation process, possible measurement and modeling issues, the REER assessment below and the External Sustainability (ES) approach.
- Key CA figures (2017):
  - Actual CA -3.9
  - Cycl. Adj. CA -3.8
  - EBA CA Norm 1.0
  - EBA CA Gap -4.8
  - Staff Adj. -1.8
  - Staff CA Gap -3.0

### Real exchange rate (REER)
- Background:
  - Sterling depreciated by 10 percent in 2016 in real effective terms relative to its average level in 2015 and by additional five percent from 2016 to 2017.
  - The depreciation may reflect in part an unwinding of past overvaluation, and in part market expectations of more restrictive access to the EU market in the future.
  - As of August 2018 the REER is unchanged relative to its 2017 average.
- Assessment:
  - EBA REER level and index approaches suggest a gap of -9.3 and -10.0 percent, respectively, for 2017.
  - The REER assessment is subject to a greater margin of uncertainty due to uncertainty about the UK’s new trading relationship with the EU and its effects on the equilibrium level of REER.
  - Overall, staff assesses the REER to be between 0 and 15 percent above the level consistent with fundamentals and desirable policy settings.
  - This range is broadly anchored on the CA assessment.
  - The weaker sterling and strong trading partner growth are expected to support further CA deficit narrowing in the near term.

### Capital and financial accounts: flows and policy measures
- Background:
  - Given the UK’s role as an international financial center, portfolio investment and other investment are the key components of the financial account.
- Assessment:
  - Large fluctuations in capital flows are inherent to financial transactions in countries with a large financial sector. This volatility is a potential source of vulnerability, although it is mitigated by sound financial regulation and supervision and a strong financial sector.
  - An additional risk is that FDI and portfolio investment inflows may decelerate driven by concerns about the UK’s future trade relations with the EU.

### FX intervention and reserves level
- Background:
  - The pound has the status of a global reserve currency.
- Assessment:
  - Reserves held by the UK are typically low relative to standard metrics, and the currency is free floating.

### Technical Background Notes
- Note: The Office for National Statistics introduced in 2017 methodological changes, revising the historical series of the CA and the NIIP. Revisions to the CA were negative in most years and related mainly to the primary income balance. In June 2018, a new round of methodological changes led to the revision of historical external series. This time, the revisions lowered the CA deficit in recent years, led by an upward revision to the trade balance as a result of improvements in the estimation of net trade earnings (which feed into exports of services).
- Footnotes and technical points:
  - 1/ The official NIIP data might understate the true position—estimates of FDI stocks at market values imply a much higher NIIP. Bank of England estimates suggest that the NIIP based on market values could be close to 80 percent of GDP in mid-2017 (November 2017 Inflation Report). Market value estimates of FDI assets assume their valuations move in line with those of equity market indices in the UK and abroad. These estimates are uncertain, as actual FDI market values could evolve differently from equity markets.
  - 2/ Staff’s estimates of valuation effects have been persistently positive even during periods without significant exchange rate depreciation (i.e. 2000 to 2007, and 2009 to 2015).
  - 3/ The ES approach provides a complementary perspective when the regression approaches yield unsatisfactory empirical fits, as in the case of the UK. This approach suggests a CA gap of about -3 percent of GDP relative to the CA level that would stabilize NFA to GDP at its 2017 level.
  - 4/ Should Brexit lead to a significant increase in trade barriers, the equilibrium exchange rate could be weaker than suggested here.

*IMF staff assessment as presented in Annex I. External Sector Assessment.*

### 1.3 percentage points both for FY19 and FY20. The debt-to GDP ratio peaks at around

### cr18316 - 1.3 percentage points both for FY19 and FY20. The debt-to GDP ratio peaks at around

### Baseline projections and key statistics
- The debt-to-GDP ratio peaks at around 96 percent of GDP in FY19 and drops below 90 percent by FY21.
- Gross financing needs rise to around 12 percent of GDP by FY20.
- Table/figure baseline values (selected):
  - Nominal gross public debt: 77.9 (2016), 96.3 (2017), 95.5 (2018), 95.5 (2019), 94.4 (2020), 90.9 (2021), 86.6 (2022), 85.6 (2023), 84.6 (projection year labeling preserved).
  - Public gross financing needs: 11.4 (2016), 9.1 (2017), 9.6 (2018), 8.3 (2019), 9.3 (2020), 9.9 (2021), 8.4 (2022), 7.2 (2023), 8.2 (projection labeling preserved).
  - Real GDP growth (in percent): 1.1 (2016), 1.7 (2017), 1.5 (2018), 1.5 (2019), 1.5 (2020), 1.5 (2021), 1.6 (2022), 1.6 (2023), 1.6 (projection labeling preserved).
  - Inflation (GDP deflator, in percent): 1.7 (2016), 2.2 (2017), 1.7 (2018), 1.3 (2019), 1.9 (2020), 1.5 (2021), 1.8 (2022), 1.8 (2023), 1.9 (projection labeling preserved).
  - Effective interest rate (in percent): 3.5 (2016), 2.3 (2017), 2.3 (2018), 2.2 (2019), 2.0 (2020), 1.9 (2021), 2.0 (2022), 2.1 (2023), 2.2 (projection labeling preserved).
  - Primary (noninterest) revenue and grants: 35.6 (2016), 36.3 (2017), 36.3 (2018), 36.2 (2019), 36.3 (2020), 36.3 (2021), 36.1 (2022), 36.1 (2023), cumulative 217.2 (labeling preserved).
  - Primary (noninterest) expenditure: 39.9 (2016), 36.9 (2017), 36.4 (2018), 36.5 (2019), 36.3 (2020), 36.0 (2021), 35.6 (2022), 35.3 (2023), cumulative 215.1 (labeling preserved).

### Stress-test scenarios and results
- Interest rate shock:
  - A 224 basis point increase in interest rates is assumed from FY19 on.
  - The effective interest rate edges up to 2.6 percentage points by FY23/24, but is only 0.4 percentage point higher than the baseline.
  - Impacts on debt and gross financing needs are expected to be mild in the medium-term, given the long average maturity of government debt.
  - Note: The exercise does not capture the decline in “de facto” maturity due to the increase in the BoE’s gilt holdings financed at Bank Rate by the creation of reserves (OBR Fiscal Risk Report 2017).
- Exchange rate shock:
  - A depreciation of 37 percent is assumed for FY19.
  - This reduces the debt ratio as the denominator effect of higher nominal GDP is only partially offset by higher spending on inflation-linked payments.
  - The scenario abstracts from the impact of inflation on other expenditures and revenues (CPI is used to uprate many direct tax thresholds, some benefits and public service pensions).
  - The increase in the stock of index-linked gilts to nearly 20 percent of GDP has increased sensitivity to changes in RPI inflation (OBR Fiscal Risk Report 2017).
  - Government actions: reduced share of index-linked to total gilt issuance from an average of 25 percent over the last five years to around 20 percent in its FY2018 financing remit; intends to keep the appropriate balance under review.
- Combined macro-fiscal scenario:
  - Aggregates shocks to real growth, the interest rate, and the primary balance.
  - Under these assumptions, the debt-to-GDP ratio reaches nearly 99 percent of GDP in FY20 and declines to around 95 percent of GDP by FY21.
  - Gross financing needs would rise to 13 percent by FY20.
- Contingent fiscal shock (banking crisis):
  - Assumes a one-time bail out raising non-interest expenditure by 3 percent of banking sector assets in FY19.
  - Real GDP is reduced by one standard deviation for two years.
  - Under this scenario, the debt-to-GDP ratio would rise to about 110 percent of GDP in FY19, and gross financing needs would peak at 21 percent of GDP.

### Stress-test assumptions (selected from figures)
- Primary Balance Shock assumptions:
  - Real GDP growth: 1.5, 1.5, 1.5, 1.6, 1.6, 1.6 (2018–2023 sequence preserved).
  - Inflation: 1.3, 1.9, 1.5, 1.8, 1.8, 1.9.
  - Primary balance: -0.3, -1.3, -1.0, 0.5, 0.8, 0.8.
  - Effective interest rate: 2.2, 2.0, 1.9, 2.0, 2.1, 2.1.
- Real GDP Growth Shock assumptions:
  - Real GDP growth: 1.5, -0.5, -0.4, 1.6, 1.6, 1.6.
  - Inflation: 1.3, 1.4, 1.0, 1.8, 1.8, 1.9.
  - Primary balance: -0.3, -0.9, -1.5, 0.5, 0.8, 0.8.
  - Effective interest rate: 2.2, 2.0, 1.9, 2.0, 2.1, 2.1.
- Real Interest Rate Shock assumptions:
  - Effective interest rate path includes values up to 2.6 in later years.
- Real Exchange Rate Shock assumptions:
  - Inflation shows a 3.0 value in one year under this scenario; effective interest rate path shows modest variation up to 2.6 in later years.
- Combined Shock and Contingent Liability Shock assumptions reflected higher effective interest rates and much larger adverse impacts on primary balance in contingent liability shock (example: primary balance -11.7 in shock year for contingent liability scenario).

### Composition of public debt and financing needs (figure highlights)
- Net debt (in percent of GDP) and Gross Nominal Public Debt (in percent of GDP) series are presented for 2016–2023 with baseline and alternative scenarios.
- Public gross financing needs projections show values rising into the 2019–2020 period (peaking around 12–13 percent of GDP under stress scenarios).

### Risk assessment and indicators
- Risk-assessment benchmarks and heat-map features:
  - Debt burden benchmark referenced: 85%.
  - Gross financing needs benchmark referenced: 20%.
  - External financing requirement benchmarks referenced: 17 and 25 percent of GDP.
  - Bond spread benchmarks referenced: 400 and 600 basis points.
  - Change in share of short-term debt benchmarks: 1 and 1.5 percent.
  - Public debt held by non-residents benchmarks: 30 and 45 percent.
- Selected indicator values and notes:
  - Bond spread (Long-term bond spread over German bonds, average 30-Jun-18 through 28-Sep-18): 98 bp.
  - Public debt held by non-residents: not applicable for United Kingdom (annotated in figures).

### Annex IV — Implementation of Fund past advice (FSAP recommendations, updates)
- Financial Stability Policy Framework:
  - Extend the Financial Policy Committee’s (FPC) powers of direction to the buy-to-let market: Implemented. Legislation came into force in early 2017.
  - Extend perimeter of concurrent stress tests to cover large foreign subsidiaries: Not implemented. BoE decision rationale and planned update to Stress-testing Approach Document following 2019 Independent Evaluation Office review.
  - Complete core data template and enhance analytical infrastructure for concurrent stress tests: Implemented/In progress. Core data templates published for 2017 Concurrent Stress Test; core data set to total 14 templates in 2019; phased replacement of Excel reporting with XBRL in 2018; new system-wide models introduced and further model development planned.
  - Develop cross-sector interconnectedness indicators using flow of funds data and other sources: In progress. BoE, FCA, and ONS engaged in Enhanced Financial Accounts project; ONS published experimental data in 2018; Flow of funds initiative to publish full experimental “from whom to whom” accounts in 2019 with ambition to incorporate into UK National Accounts in 2021; BoE research on indirect interconnectedness ongoing with completion due in 2019 H1.
- Financial Sector Oversight:
  - Increase supervisory intensity on less systemically important banks: In progress. BoE reviews supervisory approach, thematic reviews, increased seniority-level engagement, specialist reviews (capital, credit, liquidity), intel-gathering, horizon-scanning, and analytics improvements.
  - Extend scope of transparency reporting under AIFMD to cover non-EEA managers/funds where relevant: Completed. Since July 2017, the FCA obtains information from non-EEA AIFMs on their quarterly-reporting non-EEA master funds if corresponding feeder funds are marketed in the UK.

*Source: IMF staff (as presented in the supplied content).*

### 2. UK AIFMs on all their non-EEA funds not

### 2. UK AIFMs on all their non-EEA funds not

### Regulatory actions and supervision
- Ensure that Broker Crossing Networks’ (BCNs) activities are sufficiently supervised and monitored.
  - Status: In progress.
  - Following the implementation of MiFID 2, the FCA is undertaking a project to assess equity market structure in the UK through data analysis and visits to a range of UK trading venues, systematic internalisers, brokers and their buy-side customers.
  - Information gathered will be used to further assess steps taken by former BCN operators to transition to the new regime, as part of the FCA’s evaluation of the overall functioning of the market.
- Broaden the review of bank internal models to cover a greater sample of less material models and models of smaller banks.
  - Status: Implemented.
  - A program has been implemented to enhance the coverage of firms’ internal models, seeking to review at least 60% of firm’s modelled credit risk RWAs.
  - Program coverage was initially agreed by the PRA Board in May 2016 and was completed by the end of 2017.
  - Coverage met by a program of both new model reviews and thematic reviews of existing models; extended to all IRB firms, including smaller banks.
  - Risk appetite for reviewing model change permissions changed to enhance coverage of less material models.
  - UK firms participated in the EBA Article 78 RWA benchmarking exercises in 2015 (low default portfolios) and in 2016 (high default portfolios), enabling better peer comparison and identification of outliers.
- Introduce agreements similar to EIOPA requirements for colleges for insurers with significant business outside the EEA.
  - Status: In progress.
  - The PRA participates in international colleges on a regular basis; the Insurance Directorate either hosts or participates in international colleges for all Cat. 1 insurers with foreign presence.
  - The FCA participates in colleges from a conduct of business perspective and in ensuring prudential regulation impacts on consumer outcomes are considered.

### Financial Markets Infrastructure
- Consider alternative structures for oversight and management of risk within the UK High Value Payments system (HVPS) and finalize the self-assessment of the RTGS infrastructure against the Principles for Financial Markets Infrastructures.
  - Status: Implemented.
  - April 2017: FPC agreed there were financial stability risks from the current delivery structure for the HVPS and welcomed the BoE’s proposed move to a direct delivery model.
  - November (year not restated in excerpt): BoE completed transfer to direct delivery, becoming the HVPS scheme operator (previously CHAPS Co), consolidating responsibilities for operating the RTGS infrastructure.
  - Direct delivery enables a single entity to manage risks across the system.
  - The self-assessment of the RTGS infrastructure against the Principles for Financial Markets Infrastructures has been completed and published.
- Continue with the de-tiering project for payment systems and EUI and consider increasing settlement in central bank money for CCP-embedded payment system transactions (increase number of CCP members that are also members of the HVPS).
  - Status: In progress.
  - Firm-specific actions promoting de-tiering: Société Generale, Northern Trust and, in May 2018, ING joined CHAPS.
  - BNP Paribas, Northern Trust and BNY Mellon have become CREST settlement banks (EUI context).
  - As part of the RTGS review the BoE engaged with CCPs and their clearing members to discuss benefits of direct CHAPS membership and features of a rebuilt RTGS to promote broader clearing usage.
  - Further work on de-tiering now likely a medium-term deliverable given RTGS rebuild and new policy challenges.

### Crisis Management and Resolution
- Build on current arrangements to develop operating principles for funding of firms in resolution.
  - Status: Implemented.
  - Available public backstops in the UK for firms in resolution could include SMF and the Resolution Liquidity Framework.
  - Authorities mindful of FSB guidance on funding in resolution and have worked towards compatibility with the FSB’s principles, putting in place a flexible liquidity provision approach.
  - FSB published in August 2016 guiding principles on temporary funding needed to support orderly resolution of a G-SIB.
- Work with international partners to develop an effective resolution regime for insurance firms that could be systemically significant at the point of failure.
  - Status: In progress.
  - Following EIOPA’s Opinion on Harmonization of the Recovery and Resolution Framework for (Re)Insurers, work continues in international forums on practical challenges of insurer resolution regimes.
  - BoE was closely involved in developing the EIOPA Opinion; BoE engaged with the FSB in 2016 to finalize guidance on ‘Developing effective resolution strategies and plans for systemically important insurers’ and will work with systemically important insurers to implement guidance.
  - BoE involved in FSB work on Key Attributes Assessment Methodology for insurance sector.
  - March 2017: IAIS published for consultation a revised version of ICP12 (Exit from the market and resolution), including ComFrame material on resolution relevant to IAIGs; consultation closed in June 2017; BoE will continue to work with IAIS to finalize guidance.
  - EIOPA Board of Supervisors endorsed follow-up work by Project Group on Recovery and Resolution (PGRR); PGRR prepared a second phase and a draft Discussion Paper on resolution focusing on resolution funding and IGSs to gather stakeholder feedback.
- Establish an approach for engaging with countries not members of CMGs but where UK banks and CCPs have a systemic presence.
  - Status: In progress.
  - UK has established CMGs for two CCPs (LCH Ltd. and ICE Clear Europe) identified as systemic in more than one jurisdiction; CMG composition is broad and captures many jurisdictions where CCPs have systemic presence.
  - CMG work at development stage regarding resolution planning for CCPs.
  - Given wide geographic scope of LCH Ltd and ICE Clear Europe service provision, CMGs do not engage all other countries where participants are domiciled and rely on UK CCPs for clearing; proposed resolution strategies for UK CCPs expected to follow CCP rules when allocating losses, and resolvability assessed on this basis.
  - BoE presented preferred CCP resolution strategy at FSB’s fmi-CBCM forum (broader participation than UK CCP CMGs).
  - BoE’s policy approach to CCP resolution set out in BoE’s Purple Book (updated edition published in October 2017).
  - Arrangements in place with non-CMG members via “regional CMGs” for one UK G-SIB.
  - For UK banks with a presence in the EU, resolution colleges established with local regulatory authorities in line with the BRRD.
  - BoE organized resolution presentations with non-CMG members at margins of regional CMGs and supervisory Colleges, including non-core colleges and regional colleges over the past two years.
  - 2016: BoE held a training course for the Centre for Central Banking Studies (CBCS) targeted at non-CMG hosts.
  - Scope of non-CMG host authorities is shrinking as some UK G-SIBs restructure operations; BoE engagement with non-CMG host authorities has focused on HSBC and Standard Chartered.

### Box 1 — Drivers of Weak Business Investment in the UK
- Context and aggregate investment dynamics:
  - Business investment accounts for roughly 50 percent of total investment in the UK.
  - After increasing fast between 2011–2015, business investment slowed significantly in recent years.
  - The y/y growth in investment has averaged only 0.9 percent per quarter since 2016, compared to 1.8 percent before the global financial crisis.
- Model-based underperformance:
  - A basic investment model links investment to past values of GDP growth rates, user cost of capital, and lagged differences between investment and GDP levels (Bean 1981).
  - Cumulative business investment over 2016Q1–2018Q1 underperformed by 5.5 percent relative to model prediction conditional on realized economic growth.
  - Using higher counterfactual GDP growth rates instead of actual growth, model predicts business investment should have been a further 1.1 percent higher (bringing total underperformance relative to model prediction to 6.6 percent).
  - Implication: factors beyond the macro variables in the model affected investment.
- Brexit-related uncertainty and firm-level evidence:
  - Bank of England Decision Maker’s Panel survey: around 40 percent of firms consistently identify Brexit as a major source of uncertainty.
  - Analysis using Datastream-listed company balance sheet data:
    - Expected trade costs multiplied by share of foreign sales in total sales (FSTS) to measure firm exposure to Brexit-related risks.
    - Post-referendum investment spending estimated as function of that exposure and controls; results suggest potential future trade costs had a considerable and statistically significant negative impact on investment after the referendum.
  - Note: Positive and statistically significant coefficient on FSTS is consistent with sterling depreciation and stronger global growth contributing positively to investment by export-oriented firms.
- Empirical results (summary of regression table; dependent variable: investment to fixed assets (in percent)):
  - Regressions (1)–(5) include sector dummies; robust standard errors clustered at sector level.
  - Selected coefficient estimates (stars denote significance: *** p<0.01, ** p<0.05, * p<0.1):
    - Fixed assets to total assets: (1) -0.42***; (2) -0.42***; (3) -0.38**; (4) -0.27***; (5) -0.43***.
    - EBITDA: (1) 0.28; (2) 0.28; (3) 0.04; (4) 0.19; (5) 0.47*.
    - Sales to fixed assets: (1) 0.002***; (2) 0.002***; (3) 0.002***; (4) 0.001***; (5) 0.002***.
    - Total assets, log: (1) -3.47*; (2) -3.47*; (3) -3.91*; (4) -1.38; (5) -3.03**.
    - Total debt to common equity: (1) -0.08*; (2) -0.08*; (3) -0.09*; (4) -0.04*; (5) -0.09*.
    - Market to book ratio: (1) 0.0007; (2) 0.0006; (3) 0.01; (4) -0.0001; (5) -0.0009.
    - Foreign sales to total sales (FSTS): (1) 0.37*; (2) 0.39*; (3) 0.38; (4) 0.21**; (5) 0.39*.
    - FSTS*WTO trade costs: (1) -0.02**; (2) -0.02**; (3) -0.02*; (4) -0.02**; (5) -0.02**.
    - WTO trade costs (standalone in model (2)): 0.18.
    - Interest rate on debt (in model (3)): -0.05***.
    - Constant terms: (1) 78.80***; (2) 76.24**; (3) 84.96***; (4) 42.24***; (5) 77.09***.
    - Observations: (1) 270; (2) 270; (3) 227; (4) 281; (5) 225.
    - R-squared: (1) 0.32; (2) 0.32; (3) 0.33; (4) 0.30; (5) 0.30.

### Box 2 — The Impact of Different Brexit Outcomes
- Overview:
  - Summarizes staff assumptions and estimated long-run impact for three Brexit scenarios: EEA-type arrangement, a new UK-EU free trade agreement (FTA — staff baseline), and a WTO-based arrangement.
  - All scenarios assume a smooth transition to the new equilibrium; staff’s baseline is between staying in an EEA arrangement and WTO rules.
  - Scenarios illustrative and not predictions; quantification subject to large uncertainty, especially non-tariff costs.
- FTA (staff baseline) assumptions and impact:
  - UK leaves both the customs union and the single market; a new free trade deal agreed with EU.
  - Trade tariffs set at zero, while non-tariff costs rise to about half of the estimated non-tariff trade costs eliminated due to UK’s EU membership.
    - Numerically equivalent to about 10 percent average increase in tariff equivalent non-tariff trade costs.
  - UK government imposes minimum income requirement for EEA migrants; migration gradually falls by 40,000 over next twelve years relative to ONS baseline projection.
  - Estimated medium-term real GDP fall: about 2½ to 4 percent (with an average of about 3 percent) compared with a no-Brexit scenario (range from three different models).
- WTO scenario assumptions and impact:
  - Smooth transition reverting to WTO rules as basis for trade with EU; no preferential access to EU single market.
  - Non-tariff trade costs rise by the full amount of estimated past reduction due to UK’s EU membership:
    - 20 percent increase on average for goods and services.
  - Tariffs on goods trade between UK and EU assumed to rise by about 5 percent on average.
  - Net migration falls to 100,000 by 2030, about 40 percent below the baseline ONS projection.
  - Gross FDI inflows assumed to fall by about 5 percent compared to pre-Brexit WEO projection for a five-year period (equivalent to a reversal of about 20 percent of the increase in FDI inflows due to EU membership).
  - Estimated decline in level of real GDP: around 5 and 8 percent (with an average of about 6 percent) compared with a no-Brexit scenario.
- EEA scenario assumptions and impact:
  - EEA-type arrangement allows UK to keep almost full access to single market and free movement of labor but not part of customs union, implying moderate increase in non-tariff trade costs.
  - Estimated medium-term impact: about a 1½ percent reduction in real GDP relative to a no-Brexit scenario.

*International Monetary Fund — United Kingdom: Update on Progress on FSAP’s Key Recommendations (excerpt from chapter content provided)*

### Box 3. Public Indebtedness and the Pace of Fiscal Consolidation

### Box 3. Public Indebtedness and the Pace of Fiscal Consolidation

### Public debt position and vulnerability
- Public sector debt in the UK remains high.
- Countries with high levels of debt are more vulnerable to economic shocks and have less room for counter-cyclical fiscal policies (IMF Fiscal Monitor 2018).
- There is no consensus on a safe level of debt. The UK’s debt-to-GDP ratio remains below various estimates of “debt limits” (HMT 2018) but is above estimates of “debt thresholds,” where debt may begin to have adverse effects on economic activity, heighten the likelihood of future debt distress, and constrain government’s ability to stabilize the economy in case of adverse shocks.

### Baseline consolidation scenario and near-term guidance
- Strengthening resilience to shocks requires sustained consolidation to reduce the debt-to-GDP ratio.
- The size and the pace of adjustment needs to be calibrated to the country’s cyclical conditions, while taking into account the likelihood of future economic shocks.
- With the economy expected to continue operating near potential over the coming years, there is no reason to relax consolidation plans in the baseline.
- The baseline consolidation plan, including the goal of reaching a balanced budget by mid-2020s, would help debt decline to about 70 percent in ten years in the absence of shocks.
- Under the baseline plan, the probability of debt exceeding 100 percent is kept below 5 percent (under typical shocks to the baseline based on historical distributions).
- In contrast, leaving the deficit at around its current level of 2 percent of GDP would keep the debt-to-GDP ratio above 80 percent over the next decade, even in the absence of economic shocks.

### Long-term risks and stress considerations
- Over the longer term, macroeconomic risks such as recessions and financial crises are practicably unavoidable.
- Historically, the UK has averaged around one recession per decade, which could increase debt-to-GDP by 10 to 15 percentage points (OBR 2017, HMT 2018).
- Cross-country experience shows that financial crises occur once every 20 years, with a median increase in debt of about 20 percentage points.
- It is therefore important that public finances are managed prudently during good times to ensure that when shocks materialize public finances remain sustainable.

### Key methodological and modelling notes
- The 100 percent threshold corresponds to the lower bound across a range of estimates for UK debt limit.
- Forecasts and probabilities are based on simulations that combine the baseline forecast {ḡt, b̄y_t, sfā_t} for nominal growth, overall deficit to GDP, and stock-flow adjustments to GDP, with a sequence of shocks {ε_t^GDP, ε_t^primary, ε_t^r} based on their historical distributions, using the debt dynamics equation.
- Baseline GDP growth remains constant at the level of the last projection year.
- Baseline stock flow adjustments are obtained from OBR FSR 2018, and are dominated by the unwinding of the BoE’s Term Funding Scheme in FY2020–21, and by the growth in student loans over the longer term.

*Source: IMF staff calculations and Box 3, "Public Indebtedness and the Pace of Fiscal Consolidation."*

### 5. Increased public spending would provide a boost to real GDP growth in 2019,

### 5. Increased public spending would provide a boost to real GDP growth in 2019

### Growth and inflationary implications
- Growth in 2019 would be higher by ¼ percentage points compared to staff’s original projection (at about 1.7 percent), driven by the increase in fiscal spending.
- The upward revision implies that a small positive output gap would open next year, raising pressure on domestic prices and strengthening the case for further monetary policy tightening.
- Given the greater-than-usual uncertainty about the economic outlook, any increases in policy rates should still be limited and gradual.

### Fiscal measures and trajectory
- Other budget measures added up to a net giveaway of about ⅓ percent of GDP (£6bn) in 2019, which will diminish and ultimately reverse over time to become a small net takeaway by FY2023.
- Measures included:
  - minor tax cuts (a rise in the income tax personal allowance and a one-year freeze in fuel duty);
  - a small increase in non-health related spending (including an additional £0.5bn for Brexit preparations);
  - more generous payments under the Universal Credit scheme;
  - partially offset by some tax increases (including a new tax on large digital service providers).
- The largest year-on-year increase in public spending relative to the previous path is in FY2019, resulting in a fiscal stimulus in that year.

### Public finances and OBR projections
- The OBR forecasts that debt peaked at over 85 per cent of GDP in 2016-17, its highest level for 50 years.
- The fiscal rules commit the government to reducing the cyclically-adjusted deficit to below 2 per cent of GDP by 2020-21 and having debt as a share of GDP falling in that year.
- The OBR’s Budget forecast shows:
  - meeting the 2 per cent cyclically-adjusted deficit rule three years early in 2017-18;
  - cyclically-adjusted borrowing falling further to 1.3 per cent of GDP in the target year of 2020-21;
  - meeting its supplementary debt target three years early in 2017-18.

### Monetary policy stance
- The Monetary Policy Committee (MPC) raised Bank Rate by 25 basis points to 0.75 per cent in August.
- At its meeting ending on October 31, the MPC considered the current stance of monetary policy to have remained appropriate.
- The MPC judged that, were the economy to continue broadly in line with the Bank of England’s latest ‘Inflation Report’, an ongoing tightening of monetary policy over the forecast period would be appropriate to return inflation sustainably to the 2 per cent target at a conventional horizon.
- Any future increases in Bank Rate are likely to be at a gradual pace and to a limited extent.
- Unemployment rate stands at 4.0 per cent, the lowest rate since 1975.

### Financial sector resilience and stress tests
- The European Banking Authority stress test results suggest that the major UK banks would be resilient under sizable shocks; the country-specific macroeconomic scenario for the UK was the most severe among larger countries.
- Two large UK banks were among the most affected in the adverse scenario, but Common Equity Tier 1 capital ratios remained above 6 percent for all participating UK banks.
- The 2017 Bank of England stress test considered a very similar adverse scenario but also incorporated likely mitigating actions by banks.
- Adverse scenario assumptions for the UK included:
  - 3.3 percent reduction in GDP;
  - 4.5 percentage point increase in unemployment;
  - close to 30 percent decline in residential and commercial real estate prices.
- The Financial Policy Committee (FPC) maintained the UK’s countercyclical capital buffer (CCyB) rate at 1 per cent and will review the adequacy of the 1 per cent CCyB rate in its 2018 stress test assessment.

### Brexit-related contingencies and market continuity
- The European Commission has indicated that cliff-edge risks for EU access to UK CCPs can be mitigated by granting UK CCPs temporary recognition for limited duration and subject to equivalence standards; further details were not specified.
- Authorities have invested in preparations for EU withdrawal:
  - the recent Budget confirmed an additional £500 million of funding for EU withdrawal preparations;
  - meaning the government will have invested over £4 billion in preparing for EU withdrawal since 2016.
- The FPC considers the UK banking system could continue to support the real economy even in the unlikely event of a disorderly exit and judges that the system has capacity to absorb additional stresses from misconduct costs, intensifying global trade tensions, or tighter emerging-market financing conditions.

### Structural policies and productivity agenda
- Public investment set to average 2.2 per cent of GDP over the next 5 years.
- The National Productivity Investment Fund (NPIF), established in 2016, was extended by an extra year to 2023-24 and expanded to £37 billion.
- Government measures to boost productivity include:
  - cutting business taxes to support investment;
  - increased investment in housing, transport, digital infrastructure, and R&D;
  - investment in fastest, most reliable broadband connections;
  - the largest roads investment program in a generation and the biggest rail investment program since Victorian times (enabling projects such as High Speed 2);
  - increased investment in teaching of science and mathematics;
  - steps on the National Retraining Scheme and strengthening employers’ role in apprenticeships.

*Source: Statement by Ms. Shona Riach, Executive Director for the United Kingdom and Mr. Oliver James Haydon, Advisor to the Executive Director, November 12, 2018.*

---


_Source: https://www.imf.org/-/media/files/publications/cr/2018/cr18316.pdf_