## 1gbrea2024001 - 1.5 percent in 2025, as disinflation buoys real incomes, monetary policy starts easing, and ## Source details **Canonical URL:** [1gbrea2024001 - 1.5 percent in 2025, as disinflation buoys real incomes, monetary policy starts easing, and](https://www.imf.org/-/media/files/publications/cr/2024/english/1gbrea2024001.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2024/english/1gbrea2024001.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2024/english/1gbrea2024001.pdf.json) --- ### Outlook and key macro projections - Real GDP growth: - 0.7 percent in 2024; 1.5 percent in 2025; 1.7 percent in 2026. - Inflation: - Annual average: 2.7 percent in 2024; 2.1 percent in 2025; 2.0 percent in 2026. - End-of-period: 2.5 percent in 2024; 2.0 percent in 2025; 2.0 percent in 2026. - Narrative: Inflation is forecast to temporarily rise from around 2 percent presently to 2.5 percent by end-2024 due to regulated energy price base effects, before returning durably to 2 percent in early 2025. - Labor market: - Unemployment: 4.2 percent in 2024; 4.1 percent in 2025; 4.0 percent in 2026. - Risks: higher inactivity due to long term illness and population aging. - Public finances (fiscal year): - Revenue: 40.6 percent of GDP in 2023; 40.3 percent in 2024 and 2025; 40.5 percent in 2026. - Expenditure: 44.8 percent of GDP in 2023; 43.7 percent in 2024; 43.5 percent in 2025; 43.4 percent in 2026. - Public sector overall balance: -4.2 percent of GDP in 2023; -3.4 percent in 2024; -3.2 percent in 2025; -2.9 percent in 2026. - Public sector cyclically adjusted primary balance (staff estimates): -1.0 percent of GDP in 2023; -0.7 in 2024; -0.1 in 2025; 0.1 in 2026. - Public sector net debt (excl. BoE): 89.2 percent of GDP in 2023; 91.6 in 2024; 93.1 in 2025; 94.5 in 2026. - External sector: - Current account balance: -3.3 percent of GDP in 2023; -3.2 percent in 2024; -3.5 percent in 2025; -3.3 percent in 2026. - Net FDI: 2.7 percent of GDP in 2023; 0.2 percent of GDP in 2024–2026. - Reserves (end-of-period): 190.5 billions of US dollars in 2023. - Other headline stats: - Population (million): 68.1 - Per capita GDP (US$): 49,049 - Key export markets: Euro area (36%); US (21%) ### Drivers of outlook and medium/longer-term prospects - Near term drivers: - Disinflation boosting real incomes. - Monetary policy starting to ease. - Financial conditions becoming more accommodative, supporting recovery from a mild technical recession. - Medium/long-term headwinds: - Weak labor productivity growth, population aging, elevated inactivity linked to long term illness. - Pressures on public services, notably health, compounded by ongoing industrial action over pay. - Post-GFC productivity remains below pre-GFC levels despite measures to boost productivity. - Post-Brexit adjustments continue to impose adaptation costs on firms trading with the EU. - Upside and downside growth drivers: - Downside: Failure of anticipated consumption pick-up; persistent productivity and labor supply disappointment. - Upside: Stronger-than-expected second-round effects from falling energy prices (could boost growth but depress inflation), ambitious structural reforms, and AI adoption. - Inflation risk: Stronger wage pressures could lend greater persistence to services inflation. ### Monetary policy assessment and guidance - Executive Board assessment: - Directors judged the economy as approaching a soft landing; growth recovering and set to accelerate in 2025 as disinflation boosts real incomes and financial conditions ease. - Monetary policy stance and indicators: - Bank Rate paused at 5¼ percent; left unchanged at the last six MPC meetings. - Wage and services inflation remain elevated (services inflation around 5.9 percent in April; wage growth 5.7 percent April y/y). - Real shadow rate measures: - 325 bps using staff’s 1-year ahead inflation projection (2 percent in 2025Q2) with an estimated real neutral rate of around 100 bps. - 245 bps using 12-month ahead survey-based inflation expectations (2.8 percent in May). - Market-implied range: 205 bps (1-year ahead expectations) to 291 bps (5-year ahead expectations). - Staff view: given the restrictive stance, the next phase of monetary policy is to ease. - Recommended policy path and communications: - Staff sees that 50–75 bps rate cuts in 2024 would appropriately balance risks of premature vs. delayed easing. - A meeting-by-meeting approach to rate adjustment is warranted. - Enhanced MPC communication recommended, including a press conference after each rate decision, particularly if the UK path diverges from the US Fed. - Quantitative Tightening (QT) and balance sheet: - QT pace: about £100 billion a year (12-month pace starting Oct 1, 2023). - BoE reserve-related metrics: - Preferred minimum range of reserves (PMRR): £345 to £490 billion. - Sum of LCR requirement based on the stock of sterling deposit liabilities: £570 billion (as of Summer 2023). - Guidance: articulate clear rationale for future QT plans; monitor undue pressure on short-term money market rates and gilt markets; adjust QT auction sizes to smooth gilt supply. ### Fiscal policy assessment and recommendations - Main medium-term fiscal challenge: - Better account for public spending needs while assuredly stabilizing public debt. - Current stance: - Fiscal policy remains tight and continues to target medium-term debt stabilization. - Recent budgets included tax cuts aimed at boosting investment and labor supply. - Staff and Directors’ suggested revenue measures: - Stronger carbon taxation and road-usage taxation. - Broadening the base of VAT and inheritance tax. - Reforming capital gains and property taxation. - Suggested spending-side measures: - Scope for savings from state pension reforms (abolish overly-generous pensions 'triple lock' saves around 0.1 percent of GDP per year). - Any expansion or increase in user charging for public services should effectively protect the vulnerable. - Fiscal framework improvements: - Strengthen the United Kingdom’s fiscal framework. - Make fiscal rules more robust, move to a single fiscal event per year, and introduce a rolling 4–5-year expenditure framework updated every two years. - Staff proposes a probabilistic debt rule (e.g., require debt be falling by year 5 with high probability such as 75 percent). ### Fiscal consolidation scenarios and high-quality measures - Debt-stabilization adjustment scenarios (Text Table 2): - Scen. 1 (50% prob. over 5-yr horizon): Average annual excess public sector primary balance relative to staff’s baseline = 0.8; Debt level at end of horizon relative to staff’s baseline = -3.9. - Scen. 2 (75% prob. over 5-yr horizon): Average annual excess public sector primary balance relative to staff’s baseline = 1.2; Debt level at end of horizon relative to staff’s baseline = -5.9. - Scen. 3 (75% prob. over 10-yr horizon): Average annual excess public sector primary balance relative to staff’s baseline = 1.4; Debt level at end of horizon relative to staff’s baseline = -11.1. - Staff recommendation: - Keep the annual primary balance on average at least 1.2 ppts. of GDP above staff’s current baseline to project debt stabilization with higher probability (e.g., 75 percent) over five years. - High-quality revenue options (estimated yields): - Align capital gains tax rates with personal income tax: around ½ percent of GDP. - Remove unnecessary VAT exemptions: around ½ percent of GDP. - Reform property taxation (replace Council Tax): around ¼ percent of GDP. - Broad-based wealth taxation or inheritance tax reforms: around ½ percent of GDP. - Stronger carbon taxation (feebates) could provide revenue while supporting green transition. - High-quality spending options: - Abolish overly-generous pensions 'triple lock': around 0.1 percent of GDP per year. - Expand/enhance charging for public services while protecting vulnerable groups. - Pursue productivity gains from government investment in digitalization and AI within the public sector (including NHS). ### Structural reform priorities and public investment - Priority reform areas to boost potential growth and labor supply: 1. Easing planning restrictions: - Establish up-to-date, binding local plans in designated growth areas; digitalize and standardize planning processes; review limited release of low-value Green Belt land; lower stamp duty alongside council tax reform. 2. Upskilling the workforce: - More and better-quality training and apprenticeships in high-demand skills (digital and software, manufacturing, medicine and life sciences, teaching, construction); set ambitious STEM targets; simplify worker visa regime to help SMEs hire non-EU workers. 3. Improving health outcomes: - Full implementation of the NHS Long-Term Workforce Plan; real increases in capital spending; integrated and digitalized patient records; increase funding for social care; better services for those with disabilities. - Institute measures to prevent long-term sickness from scarring labor supply. - Long-term growth strategy and governance: - Adopt a clear, stable long-term growth strategy backed by an independent growth commission. - Move to a single fiscal event per year and longer projection horizons to encourage durable reforms. - Climate and green transition: - Continue reducing carbon emissions and stay the course on climate policy. - Recommend stronger feebates to hasten transition to heat pumps and electric vehicles; strengthen emissions trading and consider widening ETS coverage to road transport and buildings or upstream carbon taxes with a rising carbon price floor. - Whole-of-economy green investment increase: increase to £50 billion per year by 2030 (from £20 billion in 2020), with a public contribution of around one third. ### Financial sector, NBFIs, and macroprudential policy - Financial stability: - Resilience noted; risks well contained but warrant careful monitoring. - Major UK banks key metrics (2023Q4): CET1 ratio at 14.7 percent; LCR at 147 percent. - Non-bank financial institutions (NBFIs): - Vigilance recommended; welcome BoE initiatives: System-Wide Exploratory Scenario (SWES) exercise and design of a backstop lending tool. - NBFI data gaps remain; closing them is a priority. - Supervisory and macroprudential priorities: - Strong supervision of banks and NBFIs; close monitoring of credit conditions and financial stability risks; stringent stress tests in future calibrations. - Support maintaining CCyB at its two percent neutral level; consider releasing CCyB if tighter conditions materially increase credit losses. - Encourage making some SWES data collection permanent and ensure the NBFI lending tool design balances signaling and incentives. - LIBOR transition: - "32 of the 35 LIBOR settings have now ceased permanently." - Remaining synthetic US dollar LIBOR settings due to cease at end-September 2024. - Aggregate supervised exposures to synthetic US dollar LIBOR down to less than £31 billion from £3 trillion in 2020. ### External position and Annex I preliminary external sector assessment - 2023 assessment: - External position in 2023 was weaker than implied by medium-term fundamentals and desirable policies. - Current account deficit: 3.3 percent of GDP in 2023 (up from 3.1 percent in 2022). - NIIP: –31 percent of GDP in 2023 (from –14 percent in 2022). - Gross assets and liabilities (percent of GDP): Gross Assets 503; Debt Assets 257; Gross Liab. 534; Debt Liab. 282. - Staff-adjusted CA gap: - EBA Norm: –0.4 percent of GDP. - 2023 cyclically adjusted CA: –3.3 percent of GDP. - EBA Gap: –2.9 percent of GDP. - Staff-adjusted CA gap: –2.4 percent of GDP (within a range of –1.4 to –3.4 percent of GDP). - Policy responses to external gap: - Gradual fiscal consolidation while protecting vulnerable groups and preserving key public services. - Structural reforms to boost international competitiveness and labor reallocation. - Support open trade environment and cautious, targeted industrial policy. ### Risks, scenarios, and staff recommendations (condensed) - Risks to the outlook: - Balanced short-term risks: lower growth if consumption pick-up fails; higher growth if stronger second-round effects from falling energy prices occur (also downside risk to inflation). - Inflation persistence risk from stronger wage pressures. - Key medium-term downside risk: productivity and labor supply disappointment. - Key medium-term upside risk: ambitious structural reforms and AI adoption. - Global risks: geoeconomic fragmentation, regional conflicts, cyberthreats, global financial shocks. - Staff policy recommendations summary: - Maintain price and financial stability while durably lifting per capita growth and addressing public spending needs while credibly stabilizing debt. - Carefully calibrate timing and pace of monetary easing; clarify QT strategy and improve communication. - Pursue fiscal consolidation choices if potential growth does not materially improve; strengthen fiscal framework and adopt multi-year expenditure planning. - Implement structural reforms around planning, skills, health, and a stable growth strategy backed by an independent growth commission. - Maintain macroprudential vigilance, strengthen NBFI oversight, and continue BoE initiatives in the NBFI space. - Redouble policy efforts to achieve the UK green transition targets and remain cautious on industrial policy interventions. ### Key analytical annex highlights - Potential growth (staff): - Staff estimate long-term potential output growth: 1.3 percent. - IMF potential growth path table: IMF: 2024 1.4; 2025 1.5; 2026 1.5; 2027 1.4; 2028 1.3; 2029 1.3. - QE/QT fiscal analysis (Annex VII): - LSAPs during pandemic: purchases worth around 17.5 percent of annual GDP; cumulative post-GFC purchases around 20 percent of annual GDP. - If recovery as forecasted at time of LSAP, net fiscal stance reduction in government debt of around 2 percent of annual GDP at the 8-year horizon, despite central bank profit cumulation losses around 4 percent of annual GDP. - Earlier-tightening scenario: cumulative decrease in central bank profits due to LSAPs about 6 percent of annual GDP; medium-run impact on public debt still likely favorable but reduced. - Debt dynamics and financeability: - Public sector net debt (excl. BoE) projected to reach about 97½ percent of GDP by FY2028/29 under staff; this is an 8 ppts. of GDP increase from end-FY2023/24 levels. - Staff’s projection of public sector net borrowing will be 1½ ppts. above the OBR forecast by FY2028/29. - Debt fanchart / GFN modules indicate moderate sovereign stress risk; staff assesses overall sovereign stress risk as low. *Source: UNITED KINGDOM—STAFF REPORT FOR THE 2024 ARTICLE IV CONSULTATION (Content unit: 1gbrea2024001).* ### 1.5 percent in 2025, as disinflation buoys real incomes, monetary policy starts easing, and ### 1gbrea2024001 - 1.5 percent in 2025, as disinflation buoys real incomes, monetary policy starts easing, and ### Outlook and key macro projections - Real GDP growth: 0.7 percent in 2024; 1.5 percent in 2025; 1.7 percent in 2026. - Inflation: - Annual average: 2.7 percent in 2024; 2.1 percent in 2025; 2.0 percent in 2026. - End-of-period: 2.5 percent in 2024; 2.0 percent in 2025; 2.0 percent in 2026. - Narrative: Inflation is forecast to temporarily rise from around 2 percent presently to 2.5 percent by end-2024 due to regulated energy price base effects, before returning durably to 2 percent in early 2025. - Labor market: - Unemployment: 4.2 percent in 2024; 4.1 percent in 2025; 4.0 percent in 2026. - Risks from higher inactivity due to long term illness and population aging noted. - Public finances (fiscal year): - Revenue: 40.6 percent of GDP in 2023; 40.3 percent in 2024 and 2025; 40.5 percent in 2026. - Expenditure: 44.8 percent of GDP in 2023; 43.7 percent in 2024; 43.5 percent in 2025; 43.4 percent in 2026. - Public sector overall balance: -4.2 percent of GDP in 2023; -3.4 percent in 2024; -3.2 percent in 2025; -2.9 percent in 2026. - Public sector cyclically adjusted primary balance (staff estimates): -1.0 percent of GDP in 2023; -0.7 in 2024; -0.1 in 2025; 0.1 in 2026. - Public sector net debt (excl. BoE): 89.2 percent of GDP in 2023; 91.6 in 2024; 93.1 in 2025; 94.5 in 2026. - External sector: - Current account balance: -3.3 percent of GDP in 2023; -3.2 percent in 2024; -3.5 percent in 2025; -3.3 percent in 2026. - Net FDI: 2.7 percent of GDP in 2023; 0.2 percent in 2024–2026. - Reserves (end-of-period): 190.5 billions of US dollars in 2023. - Other headline stats: - Population (million): 68.1 - Per capita GDP (US$): 49,049 - Key export markets: Euro area (36%); US (21%) ### Drivers of outlook and longer-term prospects - Near term: Disinflation is boosting real incomes, monetary policy is starting to ease, and financial conditions are becoming more accommodative, supporting a projected recovery from a mild technical recession. - Medium and long term headwinds: - Weak labor productivity growth, population aging, and elevated inactivity linked to long term illness. - Pressures on public services, notably health, compounded by ongoing industrial action over pay. - Post-GFC productivity remains below pre-GFC levels despite implemented measures to boost productivity. - Post-Brexit adjustments continue: progress on Irish border arrangements and a review of retained EU laws have eased uncertainty, but UK firms trading with the EU are still adapting and face new rules and costs. - Upside and downside growth drivers: - Downside: Failure of anticipated consumption pick-up; persistent productivity and labor supply disappointment. - Upside: Stronger-than-expected second-round effects from falling energy prices (could boost growth but depress inflation), ambitious structural reforms, and AI adoption. - Inflation risk: Stronger wage pressures could lend greater persistence to services inflation, with monetary policy ramifications. ### Executive Board assessment and monetary policy guidance - Directors judged the economy as approaching a soft landing, with growth recovering and set to accelerate in 2025 as disinflation boosts real incomes and financial conditions ease. - Monetary policy: - Directors welcomed the rapid decline in inflation but noted wage growth and services inflation remain elevated. - With the monetary policy stance at a turning point, the timing and pace of rate cuts should balance risks of premature versus delayed easing. - The Monetary Policy Committee’s meeting-by-meeting approach to adjusting rates is considered appropriate given uncertainty. - Communication: A press conference after each rate decision could be beneficial, especially if the UK’s path diverges from US interest rates. - Quantitative Tightening (QT): Important to articulate a clear rationale for future QT plans as the BoE’s balance sheet approaches its steady-state size. Some Directors supported staff’s high-level principles for BoE capital policies in future QE/QT rounds. - Directors welcomed the BoE’s commitment to act on the recommendations of the Bernanke Review. ### Fiscal policy assessment and recommendations - Main medium-term fiscal challenge: Better account for public spending needs while assuredly stabilizing public debt. - Fiscal policy stance: Remains tight and continues to target medium-term debt stabilization; last two budgets included tax cuts aimed at boosting investment and labor supply. - Staff and Directors’ suggested revenue measures: - Stronger carbon taxation and road-usage taxation. - Broadening the base of VAT and inheritance tax. - Reforming capital gains and property taxation. - Suggested spending-side measures: - Scope for savings from state pension reforms. - Any expansion or increase in user charging for public services should effectively protect the vulnerable. - Fiscal framework improvements: - Strengthen the United Kingdom’s fiscal framework. - Make fiscal rules more robust, move to a single fiscal event per year, and introduce a rolling 4–5-year expenditure framework updated every two years. ### Structural reform priorities and public investment - Directors and staff emphasize more ambitious structural reforms to boost potential growth: - Ease planning restrictions to streamline and make decision-making more predictable, reducing construction delays and costs and enhancing labor mobility. - Upskill the workforce to address skill gaps in digital and software, manufacturing, medicine and life sciences, teaching, and construction. - Improve health outcomes through capital and workforce investment in the National Health Service and efficient resource allocation to prevent long-term sickness from scarring labor supply. - Adopt a clear and stable long-term growth strategy backed by an independent growth commission. - Climate and green transition: - Continue progress in reducing carbon emissions and stay the course on climate policy. - Recommend stronger feebates to hasten the transition to heat pumps and electric vehicles and strengthening emissions trading to support the carbon price. - Ensure adequate public investment to support the green transition. ### Financial sector and macroprudential policy - Financial stability: Resilience noted; risks appear well contained but warrant careful monitoring. - Non-bank financial institutions (NBFIs): Vigilance recommended; welcome BoE initiatives including a system-wide exploratory scenario exercise and the design of a backstop lending tool. - Supervisory priorities: - Ongoing strong supervision of banks and NBFIs. - Close monitoring of credit conditions and financial stability risks, including stringent stress tests in future calibrations. - Continue progress closing data gaps and enhancing the effectiveness of the AML/CFT supervisory regime. - Edinburgh reforms: Preservation thus far of the primacy of financial stability objectives welcomed, but continued vigilance urged. ### Risks, scenarios, and staff recommendations (condensed) - Risks to the outlook are balanced. - Short-term: Lower growth if consumption pick-up fails; higher growth if stronger second-round effects from falling energy prices materialize (also a downside risk to inflation). - Inflation persistence risk from stronger wage pressures. - Key medium-term downside risk: Productivity and labor supply disappointment. - Key medium-term upside risk: Bold implementation of ambitious structural reforms and AI adoption. - Staff policy recommendations summary: - Maintain price and financial stability while durably lifting per capita growth and addressing public spending needs while credibly stabilizing debt. - Carefully calibrate timing and pace of monetary easing; clarify QT strategy and ensure effective communication. - Pursue fiscal consolidation choices if potential growth does not materially improve; strengthen fiscal framework and adopt multi-year expenditure planning. - Implement structural reforms around planning, skills, health, and a stable growth strategy backed by an independent growth commission. - Maintain macroprudential vigilance, strengthen NBFI oversight, and continue BoE initiatives in the NBFI space. - Redouble policy efforts to achieve the UK green transition targets and remain cautious on industrial policy interventions. *Source: UNITED KINGDOM—STAFF REPORT FOR THE 2024 ARTICLE IV CONSULTATION (mission took place in London during May 7–21, 2024).* ### 3. On May 22, one day after the Article IV mission conclusion, it was announced that UK ### 1gbrea2024001 - 3. On May 22, one day after the Article IV mission conclusion, it was announced that UK ### Recent Economic Developments - Growth was 0.6 percent q/q in 2024Q1, marking a stronger-than-expected exit from the technical recession in the second half of 2023. - Full-year growth in 2023 was 0.1 percent (0.4 ppt. below January WEO). - The 2023 slowdown was driven by weak household consumption due to higher interest rates and cost of living pressures, partially offset by stronger government spending and business investment. - High-frequency indicators (PMIs, consumer and business confidence, retail sales, housing market) point to a recovery and suggest private consumption should pick up in coming quarters. ### Inflation and Labor Market Developments - Headline inflation: 2.3 percent y/y in April. - Core inflation: 3.9 percent y/y in April. - Wage growth: 5.7 percent (April y/y). - Services inflation: 5.9 percent (April y/y). - Momentum in wage growth and services inflation recently edged up to above 5 percent. - May DMP survey expected pay growth: 4.1 percent (from 4.6 percent in April). - Vacancy-to-unemployment ratio fell from a peak of 1.4 in 2022 to 0.6 percent in December 2023; broadly stabilized at that level. - 2012–2019 average vacancy-to-unemployment ratio: 0.4. - Rent inflation: 9 percent in April. - Mortgage arrears reached a 7-year high in 2023Q4 (more than half were originated before 2008) but remain well below the GFC peak. ### Monetary Policy and BoE Actions - Bank Rate left unchanged at the last six MPC meetings; rate paused in September at 5¼ percent. - MPC shifted to neutral forward guidance in February: “we will adjust rates as economic data warrants.” - In March and May meetings, no MPC member voted for a rate hike, signaling a move toward rate cuts. - Market pricing (as of late May) suggests a first 25 bps rate cut in November, and a total of 40 bps cuts in 2024. - BoE quantitative tightening (QT) pace broadly maintained at about £100 billion a year (once account is taken of offloading corporate bond holdings) for the 12 months starting October 1, 2023. - In December, the BoE adjusted QT auction sizes to balance short-, medium-, and long-term gilts supplied in initial proceeds terms. ### Financial Conditions and Credit - Financial conditions have eased since May 2023, reflecting: - effective appreciation of the exchange rate, - easing in credit spreads on high-yield and investment-grade corporate bonds, - recovery in equity and house prices. - Private credit has grown in nominal terms, mostly driven by non-bank lending to corporates. - Credit to GDP has continued to decline and the credit gap has remained negative. - Recent bank lending survey points to a recovery in credit supply. - Transmission of monetary tightening through mortgages has been slower than in previous cycles due to a higher share of fixed-rate mortgages. - BoE projects aggregate mortgage debt service ratio and share of households with high debt service ratios to continue increasing throughout 2024, but remain well below the GFC peak. ### Real Estate Developments - Residential house-price correction concerns have not materialized; house price-to-income ratio remains above long-term average and relative to peers. - House price growth turned positive since December. - Net mortgage approvals are rising from low levels as rates have eased from summer highs. - Commercial real estate (CRE) fell by over 13 percent in 2022, appears to have bottomed out in 2023 and shows signs of recovery in 2024Q1. - Direct exposure of UK banks and NBFIs to the CRE sector remains relatively limited. ### Fiscal Policy - Fiscal policy remains restrictive; modest windfalls used mainly for tax cuts over the past year. - OBR’s medium-term revenue/GDP ratio was upgraded by 2 ppts. in the 2023 Autumn Statement due to higher inflation-induced fiscal drag (income tax thresholds frozen till FY 2028/29). - Windfall spent on: - making permanent the full expensing of plant and machinery investment, - a 2 ppts. cut to the main rate of National Insurance Contributions (NICs). - 2024 Spring Budget: revenue yield from revenue-raising measures more than fully offset by a further 2 ppts. cut to the main NIC rate. - Overall fiscal stance in 2024 and 2025 remains restrictive, including due to tight spending limits through FY2024/25. - Conditioning assumption: fiscal impulse assumed contractionary in 2024 (around -0.25 percent1), and to gradually converge to neutral over the forecast horizon. - Non-interest expenditure assumed to be around 1½ ppts. of GDP above the OBR’s projection by FY2028/29 to account for critical spending needs. ### External Position - Current account deficit widened from 3.1 percent of GDP in 2022 to 3.3 percent in 2023. - Worsening in 2023 included a 1.6 ppts. of GDP deterioration in the income balance (higher net interest payments) largely offset by a 1.4 ppts. of GDP improvement in the trade balance (mainly due to lower energy prices). - Exchange rate appreciated by about 2½ percent in real effective terms in 2023. - Preliminary estimates suggest external position in 2023 was weaker than implied by medium-term fundamentals and desirable policies. ### Outlook and Risks - Staff baseline growth forecasts: - 2023: 0.1 percent. - 2024: 0.7 percent. - 2025: 1.5 percent. - Staff upgraded 2024 growth forecast from April WEO (0.5 percent) due to stronger-than-expected 2024Q1 GDP. - Staff estimate long-term potential growth at 1.3 percent. - Factors weighing on long-term potential growth: uptick in inactivity related to long term illness; population aging; diminishing contribution from migration; weak recovery in labor productivity (low TFP growth; extended under-investment). - Inflation projections: - Inflation forecast to fall to around 2 percent in 2024Q2, rise to around 2½ percent later in 2024, and fall durably to 2 percent in 2025Q2. - Core inflation projected to decline more slowly, reaching 2 percent levels only in the second half of 2025. - Risks: - Inflation could be higher or lower depending on persistence of wage and services inflation. - Growth could be lower if consumption pick-up does not materialize or higher if stronger-than-expected second-round effects from falling energy prices occur. - Downside risks from geoeconomic fragmentation, intensification of regional conflicts, cyberthreats, global financial stability shocks. - Key downside risk to medium-term growth: investment and TFP do not pick up and labor supply disappoints. - Upside risks: bold structural reforms and AI adoption. ### Authorities’ Views and Policy Discussion - Authorities note economy “turning a corner” and acknowledged staff’s upward revision to 2024 growth. - Authorities caution on Q1 GDP expenditure composition as often revised; noted staff’s medium-term growth forecasts lie between OBR and BoE projections; staff’s longer-term potential growth estimate is lower than both OBR and BoE. - Authorities hopeful productivity could rebound faster; recent measures (NIC cuts, working age benefits reforms) could boost labor supply and growth more than OBR costings. - Policy priorities and recommendations from staff: - Sustain monetary policy path to bring inflation back to target; consider recalibration of QT strategy and BoE communications. - Main medium-term fiscal challenge: stabilize public debt while managing pressures on public services; requires difficult choices on taxation and spending priorities. - Implement bold reforms in planning, skills, and healthcare to boost labor productivity and labor supply. - Maintain macroprudential vigilance, notably toward the non-bank sector. - Maintain open trade orientation and take a cautious approach to industrial policy. - Redouble efforts to credibly achieve green transition targets, which are at greater risk after the September loosening of some climate policies. *Source: 1gbrea2024001.* ### 16. Monetary policy has reached an inflection point. While wage and services inflation ### 16. Monetary policy has reached an inflection point. While wage and services inflation ### Inflation and monetary stance: key findings - Wage and services inflation remain high at around 6 percent. - Upper tails of survey- and market-based inflation expectations still exceed historical averages. - Wage and price-setting expectations for the next 12 months have eased to 4.1 and 3.8 percent, respectively, in May. - Core inflation momentum (3m/3m) has moderated. - Staff’s baseline foresees headline inflation to already reach 2 percent this quarter; inflation will then rise to around 2½ percent in Q4. - Real shadow rate measures of monetary restrictiveness: - Real shadow rate using staff’s 1-year ahead inflation projection (2 percent in 2025Q2) is 325 bps; with an estimated real neutral rate of around 100 bps, this implies a significantly restrictive monetary stance. - Real shadow rate is 245 bps using the 12-month ahead survey-based inflation expectations (2.8 percent in May). - Market-implied inflation expectations yield a real shadow rate ranging from 205 bps (using 1-year ahead expectations) to 291 bps (using 5-year ahead expectations). - Policy implication: given the restrictive stance, the next phase of monetary policy is to ease. ### Policy recommendation on Bank Rate - Staff sees that 50–75 bps rate cuts in 2024 would appropriately balance risks of premature vs. delayed easing. - Risks: - Premature easing: could re-ignite inflation persistence via regulated energy price base effects and lead to de-anchoring of inflation expectations. - Delayed easing: keeping Bank Rate constant as inflation and inflation expectations fall would raise ex-post real rates, which could stall or reverse the recovery and produce extended undershooting of the inflation target. - Approach: a “meeting by meeting approach” is warranted given significant uncertainties and incoming data risks; monetary policy should be adjusted if inflation deviates notably from the baseline. ### Market dynamics and communication - Since the start of the year the market has lowered its expectations of rate cuts in 2024 (to about 40 bps since late May), reflecting higher-than-expected inflation data in the US and UK. - Possible divergence from the US Fed’s rate path increases the premium on effective MPC communication with markets. - Empirical finding: Fed announcements were largely supportive of UK monetary policy transmission in the pre-COVID period, but in the current tightening cycle market reactions to Fed and MPC decisions sometimes went in opposite directions (example: December 2023). - Staff proposal: the BoE should enhance the frequency of its monetary policy communications with markets, including by holding a press conference after each MPC decision, to elaborate or caveat MPC views when market reactions to Fed decisions are inconsistent with MPC objectives. - MPC has highlighted the need to see-through regulated energy price base effects and wait for clearer signs of receding inflation persistence. ### Quantitative Tightening (QT) and balance sheet strategy - QT implementation to date: operating at a pace of £100 billion gilt reduction per 12 months. - Timing: at current pace and given expected maturities of the Term Funding Scheme with additional incentives for SMEs (TFSME), the level of reserves may approach the estimated range for the BoE’s steady-state balance sheet size as soon as the second half of 2025. - BoE reserve-related metrics: - Preferred minimum range of reserves (PMRR) indicated by BoE survey: £345 to £490 billion. - Sum of LCR requirement based on the stock of sterling deposit liabilities: £570 billion (as of Summer 2023). - Guidance: - A clear rationale for future QT plans to converge to a steady-state balance sheet is critical. - QT strategy should continue to be guided by MPC principles: leave Bank Rate as the active monetary policy instrument and not disrupt smooth market functioning. - The BoE should monitor undue pressure on short-term money market rates and gilt markets and adjust QT implementation as needed. - Staff supports BoE adjustment on QT auction sizes to smooth gilt supply across maturities. - Steady-state balance sheet composition (gilts vs. short-term repos) should ensure money market rates remain aligned with the policy rate, while considering banks' demand for reserves and high-quality liquid assets. ### QE/QT fiscal and institutional considerations - Staff analysis: QE/QT could be neutral or beneficial to the fiscal position over the cycle, with direct profit transfers and indirect fiscal benefits during QE potentially outweighing losses during QT (Annex VII). - Stakeholder concern: large APF losses during the current tightening cycle have led some to suggest QE/QT decisions pass a narrow value-for-money test, which could affect the BoE’s ability to independently carry out its mandate. - Staff high-level principles for capital policies governing future QE/QT rounds: - (i) The treatment of profits/losses should be fully transparent, ex-ante, and symmetric (as currently the case). - (ii) The size and frequency of transfers between the Treasury and the BoE arising as a result of QE/QT profits/losses should be reduced, to insulate the BoE from political pressure. - (iii) The profits/losses should be included in the debt definition used for the fiscal rule (as currently), but there would be a case to exclude the profits/losses from any annually-applying deficit rule. ### BoE forecasting, data, and communications: Bernanke review implications - Bernanke review findings (summary): - (i) BoE’s forecasting performance has worsened in recent years but is not worse than that of other central banks and other UK forecasters. - (ii) Significant shortcomings exist in the BoE's central forecasting model (COMPASS) and data platforms. - (iii) The central forecast, used as a communication device, may not fully reflect MPC's view because it is conditioned on standard assumptions that "may not always accurately represent the views of the MPC". - The Review made 12 recommendations on improving forecasting infrastructure, publishing alternative scenarios, and retiring the inflation fan chart; it stopped short of formally recommending publication of MPC policy rate path(s). - Staff advice: - In designing “alternative scenarios,” consider including scenario-specific monetary policy paths generated by BoE staff to support MPC decision-making and communications. - Allocate adequate resources to enhance and maintain required modeling infrastructure. - BoE commitment: BoE has committed to act on the recommendations and is progressing work on data and modeling infrastructure. ### Authorities’ views and BoE actions - MPC action: voted to maintain Bank Rate at 5.25 percent in May and stated it would “continue to monitor closely indications of persistent inflationary pressures and resilience in the economy as a whole”. - Range of MPC views: differing perspectives exist on the role of second-round effects in domestic inflation persistence. - Communication approach: MPC members did not see an immediate need for major changes to communication but will consider staff’s suggestion for a press conference after every rate decision in the context of implementing Bernanke Review recommendations. - QT governance: QT has been operating in the background as intended, leaving Bank Rate as the active policy tool; BoE will conduct its annual QT review this summer to inform pace for next 12 months. - Steady-state balance sheet (SSBS) work is progressing; Short-Term Repo (STR) facility availability (launched in 2022) supports independent QT decisions as APF reduces reserve supply. - BoE view on APF indemnification: current indemnification arrangement is viewed as clear and transparent; BoE noted Fund staff's high-level principles on capital policies for future QE/QT rounds. ### Fiscal policy: consolidation and outlook - Fiscal consolidation since November 2022 delivered a restrictive near-term fiscal stance to rebuild buffers. - Primary deficit improvements: - Primary deficit fell from 3.6 percent of GDP in FY2021/22 to 1.3 percent of GDP in FY2023/24 (broadly pre-pandemic level). - Consolidation drivers: 6 ppts. increase in the corporation tax rate, freezing of personal income tax thresholds, and tight limits on spending reduced deficits; recent budgets included tax cuts as well. - Staff view: would have recommended against the NIC rate cuts given their significant cost (½ percent of GDP per year) though recognizes potential labor supply benefits and partially offsetting measures (e.g., reform of the 'non-dom' regime). ### Fiscal projection differences and debt path - Staff’s baseline adjustments to spending: - Staff assumes real growth of DEL spending around two percent per year over the medium term and real growth of public investment and spending for the green transition. - Non-interest AME is assumed to rise with inflation and population growth. - Net effect: non-interest spending declines by only ¾ ppt. of GDP between FY2023/24 and FY2028/29 under staff, compared with a 1.7 ppts. decline in the OBR forecast. - Borrowing and debt outcomes: - Public sector net borrowing will be 1½ ppts. above the OBR forecast by FY2028/29 under staff projections. - Public sector net debt (excl. BoE) continues to rise over the medium-term to reach about 97½ percent of GDP by FY2028/29 (OBR projects about 93 percent of GDP), an 8 ppts. of GDP increase from end-FY2023/24 levels. - Sovereign stress risk: still assessed as low, but non-stabilization of the debt/GDP ratio over five years is a deterioration from the last Article IV. ### Fiscal sustainability and required adjustment - Absent major boosts to potential growth, additional consolidation will be needed for debt stabilization. - Required fiscal effort depends on target stabilization probability, horizon, and accommodation of spending pressures. - Text Table 2 — Fiscal effort to achieve debt stabilization: adjustment scenarios (ppts. of GDP) - Scen. 1 (50% prob. over 5-yr horizon): Average annual excess public sector primary balance relative to staff’s baseline = 0.8; Debt level at end of horizon relative to staff’s baseline = -3.9. - Scen. 2 (75% prob. over 5-yr horizon): Average annual excess public sector primary balance relative to staff’s baseline = 1.2; Debt level at end of horizon relative to staff’s baseline = -5.9. - Scen. 3 (75% prob. over 10-yr horizon): Average annual excess public sector primary balance relative to staff’s baseline = 1.4; Debt level at end of horizon relative to staff’s baseline = -11.1. - Staff recommends an adjustment path to keep the annual primary balance on average at least 1.2 ppts. of GDP above staff’s current baseline to project debt stabilization with higher probability (e.g., 75 percent) over five years. ### High-quality consolidation options - Revenue-side options (estimated fiscal yields): - Aligning the rates of capital gains tax with equivalent rates of personal income tax: around ½ percent of GDP. - Removing unnecessary VAT exemptions: around ½ percent of GDP. - Reforming property taxation (replacing Council Tax with a broad-based property tax): around ¼ percent of GDP. - Broad-based wealth taxation or reforms to inheritance taxation (removing unnecessary reliefs): around ½ percent of GDP. - Stronger carbon taxation (use of feebates) could provide revenue while supporting the green transition. - Spending-side options: - Abolish the overly-generous pensions 'triple lock', saving around 0.1 percent of GDP per year. - Expand or enhance charging for public services while protecting the vulnerable. - Pursue productivity gains from government investment in digitalization and AI within the public sector (including the NHS), though savings are difficult to quantify. - Implementation caveat: these revenue and spending measures should be part of a broader pro-growth structural reform agenda and support the climate transition. *Source: IMF staff analysis and recommendations as presented in the extracted chapter.* ### 29. Against the backdrop of these challenges, as a general principle, staff advises against ### 1gbrea2024001 - 29. Against the backdrop of these challenges, as a general principle, staff advises against ### Fiscal stance and near-term recommendations - Staff advises against additional tax cuts as a general principle unless they are credibly growth-enhancing and appropriately offset by high-quality deficit-reducing measures. - Automatic stabilizers should be allowed to operate if growth disappoints, but discretionary stimulus should be well targeted to protect the vulnerable and mindful of debt sustainability risks. - The UK’s revenue/GDP ratio is noted as well below the level in G7 European peers while some welfare-state elements (e.g., healthcare) remain similarly expansive. ### Fiscal rules and institutional reforms - Current rules: PSND (excl. BoE) must fall by the fifth year and PSNB must fall below three percent of GDP. - Assessment of current rules: - These rules are described as insufficiently constraining in the near-term and encouraging unrealistic assumptions further out. - Staff proposes a probabilistic approach for the debt rule under which debt must decline in the fifth year with a high probability; the “additional effort” table shows results with 75 percent. - The probabilistic approach could be nested within a higher-level fiscal standard that sets a bar for “responsible” fiscal policy. - Staff does not support exclusion of QE/QT profits/losses from the fiscal aggregates used to assess compliance with the debt rule, since net losses of QE/QT are liabilities of the public sector. Staff could support exclusion from flow aggregates in a future fiscal rule (e.g., an annually-applying deficit rule) subject to monetary-principles considerations. - Empirical note: - The OBR in March 2024 assessed—based on a debt fanchart—that there was a 54 percent probability of debt falling in year 5 (this result obtains because the OBR uses the government’s unrealistically low spending projections after end-March 2025). - The change proposed would be to raise the “even chance” to a high probability like 75 percent or 95 percent. ### Enhanced OBR role and budget process changes - Enhanced OBR responsibilities proposed: - Require the OBR to provide an updated forecast whenever there is a major fiscal policy change. - Extend the OBR’s forecast horizon in the Economic and Fiscal Outlooks to ten years to better capture longer-term spending pressures and dividends from growth-enhancing investments. - Seek the OBR’s public views on any changes to fiscal rules at the time of consideration. - Give the OBR a role in determining when escape clauses to fiscal rules are triggered. - Budget process reforms: - Transition from semi-annual to annual budgets to streamline the process and reduce political pressure for fiscal loosening. - Improve credibility of the medium-term fiscal framework by providing visibility on spending plans for at least three years ahead via medium-term (four or five-year) spending ceilings, updated every 2 years based on detailed assumptions and policies. - Replace the current periodic spending reviews (three-year DEL limits) with the proposed medium-term framework to provide greater certainty for capital spending projects. ### Authorities’ views (summary) - Authorities noted fiscal rules were being met under the OBR’s independent forecast, acknowledged uncertainty over expenditure allocations pending the next spending review, and explained NIC rate cuts and disability benefit reforms were designed to incentivize work. - Authorities cited recent funding increases for the NHS, social care and schools to address immediate challenges and longer-term strategies such as the NHS Long-Term Workforce Plan. - On fiscal framework reforms, the authorities saw merit in exploring the role that the probability of debt stabilization could play in future reviews and noted staff’s recommendations regarding a single fiscal event and rolling four or five-year spending frameworks updated twice a year. - Authorities concurred with staff’s assessment of sovereign risks, underlying assumptions, and the extent of fiscal space. ### Reforms to boost growth — diagnosis - The UK has faced a major trend growth and productivity slowdown since the GFC; combined shocks (Brexit, COVID, energy price surge) and longer-term trends (aging) have left UK GDP around a quarter below the level implied by pre-GFC trend. - Labor productivity growth fell from around 2 percent pre-GFC to around ½ percent thereafter. - Declines in firm dynamism post-GFC, loss of North Sea Oil and a leverage-driven financial boom, and low TFP-supporting investment have contributed to the slowdown. - Aging and policies to rein in immigration are expected to constrain total hours worked going forward. - Inequalities and spatial disparities noted: - Homeownership by age 34 fell from 70 percent in the 1950s to less than 34 percent today. - Income per head in London was around 22 percent higher than the UK in 1997, rose to 37 percent in 2008, and reached 43 percent in 2021. - Northeast income per head was 86 percent in 1997, 81 percent in 2008, and 81 percent in 2021. ### Reforms to boost growth — prioritized policy areas and recommendations - Three priority reform areas identified as relatively less costly fiscally and likely to improve competitiveness and the external position: 1. Easing planning restrictions - Problem: Excessively stringent planning regime inhibiting housing and infrastructure construction, constraining labor mobility and widening regional disparities. - Evidence: Cheshire (2015) estimates the attendant TFP effect at a massive 32 percent for some businesses. - Key reforms recommended: - Establish up-to-date, binding local plans to streamline decision-making in designated growth areas with incentives and additional resources to local authorities. - Digitalize and standardize planning processes to reduce delays and increase transparency. - Institute broader geographic and rules-based decision-making for business developments to decrease uncertainty for investors. - Introduce targeted incentives and resources for local authorities, including skilled staff, to facilitate compliance with new environmental requirements. - Carefully review the scope to release Green Belt land of little environmental or amenity value near stations with easy access to major cities. - Ensure better housing standards and higher-quality housing across all income groups, particularly in the private rented sector, alongside flexible land use policies. - Lower stamp duty for both residential and non-residential properties (alongside a reform of the council tax to ensure net revenue gain) to stimulate high-growth firm activity and facilitate workforce mobility. 2. Upskilling the workforce - Problem: Larger skills gaps than in peer countries, recruitment difficulties limiting output in high-skill sectors (digital and software, manufacturing, medicine and life sciences, teaching, construction), declining STEM outcomes and workplace training. - Key reforms recommended: - Provide more and better-quality training and apprenticeships in high-demand skills, including via higher government support. - Set ambitious targets consistent with a reversal of the recent decline in STEM outcomes. - Implement schemes to encourage younger workers to enter future growth sectors and improve retention. - Simplify the worker visa regime to facilitate smaller employers hiring non-EU workers. 3. Improving health outcomes - Problem: Rising inactivity driven by long-term sickness and disability contributing to labor supply and productivity drags; more than 20 percent of the population recorded as having disabilities (above G7 peers). - Resource context: - Number of hospital beds, doctors, and nurses per capita lower than the OECD average. - Authorities committed to the NHS Long-Term Workforce Plan aiming to increase NHS staff numbers by around 800,000 over the next ten years. - Spring Budget announcement of £3.4 billion (0.1 percent of GDP) to support efficiency improvements using digitalization and AI. - Key reforms recommended: - Full implementation of the NHS Long-Term Workforce Plan, accompanied by real increases in capital spending. - Pursue a forward-looking and integrated approach to NHS resource allocation and strategic decision making focused on system-wide performance (e.g., integrated and digitalized patient records). - Increase funding for social care commensurate with demand over the medium-term. - Improve health services for those with disabilities (including mental health), while ensuring those capable of work are incentivized to do so and assisted through training, coaching, and integrated health support. - Fiscal implication: - The Institute of Fiscal Studies estimates health spending may need to rise by 2 percentage points of GDP by the FY2036/37 to fund the NHS Long-Term Workforce Plan, which seeks to avoid a labor shortfall of between 260,000–360,000 staff emerging by the mid-2030’s. ### Long-term growth strategy and governance - Staff proposes the authorities adopt a clear and stable long-term growth strategy, potentially anchored in the advice of an independent growth commission (similar to Australia’s productivity commission). - Rationale: - Reduce recurrent and piecemeal policy changes and semi-annual fiscal events that increase planning uncertainty for businesses and workers. - A single fiscal event each year and longer official projection horizons may incentivize a stable growth agenda with reforms that yield payoffs beyond the electoral cycle. - An independent growth commission could take a longer-term view, better coordinate across levels of government, and track and report on implementation. ### Industrial policy stance - Staff supports the authorities’ cautious approach to industrial policy, favoring broad-based tax incentives for business investment and R&D over extensive vertical interventions. - Recent measures: - Advanced Manufacturing Plan (November 2023) committing £4.5 billion (0.2 percent of GDP) in strategic investment in high-technology sectors mainly as grant funding for R&D and investment. - Around £1 billion each (0.1 percent of GDP) committed to a Green Industries Growth Accelerator and for creative industries. - Announcement of 13 investment zones and 12 free ports offering tax concessions and other targeted support. - Staff recommendation: - Keep plans narrowly targeted toward removing obstacles to investment and improving the business environment, focusing on industries/firms where externalities or market failures prevent effective market solutions while minimizing trade and investment distortions and adverse international spillovers. - Continue active and constructive participation in the WTO. *Source: IMF staff report content (Content unit: 1gbrea2024001).* ### 36. Authorities’ Views. The authorities’ acknowledged the importance of further ambitious, ### Authorities’ Views ### Structural Reforms, Labor Supply, and Health - Authorities acknowledged the importance of further ambitious, evidence-based structural reforms to boost investment, productivity and labor supply and noted that this was their preferred means of building fiscal buffers while addressing spending needs. - Agreed with staff on key reform priorities and noted recently implemented reforms: - Planning reforms and full expensing (for qualifying plant and machinery business investments). - Cuts in the NIC rate, which should support labor supply. - On rising inactivity due to long term sickness: - Authorities highlighted reforms to working age benefits to ensure people capable of work are incentivized to do so, while emphasizing adequate support through training and coaching and ensuring access to healthcare. - Authorities opined that the main issue in healthcare was efficiency but acknowledged the need for capital investment, including in digital infrastructure, which was announced during the Spring Budget. - Skills and apprenticeships: - Addressing skills gaps was a priority with emphasis on digital and AI, STEM, life sciences and the creative arts, particularly for the young, and for older workers through lifelong learning. - Measures put in place to improve the quality of apprenticeship programs were cited as partly explaining the decline in total numbers; recent efforts also aim to grow apprenticeship numbers in key sectors and incentivise SMEs to create opportunities for young people. - Authorities were receptive in principle to the idea of a growth commission. ### Financial Sector Policies — Systemic Risk Assessment - Overall level of systemic risk assessed as broadly similar to the previous Article IV consultation, with focus shifting from households to corporations. - Household debt vulnerabilities have reduced somewhat, supported by strong wage growth and a lower expected policy rate path, while corporate vulnerabilities have edged up, mainly for firms exposed to some segments of market finance. - Banking sector is healthy; vulnerabilities in the more complex NBFI sector (including high leverage and liquidity mismatch, and lack of data) remain a source of concern. - Risk premia have decreased further below historical averages across several asset classes; a sharp correction in a broad range of asset prices could crystalize long-standing vulnerabilities in market-based finance. - Global risks remain elevated, including from heightened geopolitical tensions, corrections in CRE markets globally, and the property market in China, which could spill over to the UK financial system. ### Macroprudential Settings and Stress Testing - Macroprudential settings are appropriate but continued close monitoring of credit conditions and financial stability risks is merited. - Credit conditions remain muted, particularly for smaller businesses and certain sectors. - IMF global stress testing showed that in an adverse scenario, UK banks remain resilient, echoing the BoE’s 2022/23 stress testing results. - Staff supports FPC’s decision to maintain the countercyclical capital buffer (CCyB) at its two percent neutral level. - Recommendation: Should tighter financial conditions materially increase credit losses, authorities should consider easing prudential policy (for example, releasing the CCyB) to avoid exacerbating a credit downturn. - In light of potential valuation risks in several asset markets, continued monitoring and appropriately stringent stress tests are important. ### Banking Supervision and Resilience - Major UK banks remain healthy; continued strong supervision warranted. - Key metrics for major UK banks in 2023Q4: - CET1 ratio at 14.7 percent - LCR at 147 percent - Diverse business models of smaller banks merit continued close monitoring as stress in this segment has been idiosyncratic. - Staff supports BoE’s decision to conduct desk-based top-down stress testing this year to complement bottom-up approaches and encourages further use of stress testing tools to identify risks in smaller banks. - PRA progress on the new Strong and Simple Framework to simplify the prudential framework for non-systemic domestic banks and building societies, while maintaining resilience, was noted. ### Nonbank Financial Intermediation (NBFI) — Monitoring, Tools, and Data - Ongoing initiatives to enhance risk monitoring and crisis response readiness for NBFIs have gained momentum but challenges remain. - System-Wide Exploratory Scenario (SWES): - Staff welcomes progress and looks forward to insights on resilience, reaction functions to stressed market conditions, and propagation channels. - Staff encourages considering making some data collection permanent for ongoing system-wide stress testing capacity. - NBFI lending tool: - Progress welcomed; aims to act as a backstop to core markets by providing liquidity to appropriately regulated and systemically interconnected NBFIs while avoiding moral hazard. - First step: facility accessible for pension funds, insurance companies, and LDI funds. - Staff urges design to balance signaling BoE readiness and preserving incentives for NBFIs to enhance resilience; encourages continued regulatory coordination to ensure resilience of non-UK domiciled funds. - Bank has recently announced some preferred design features (e.g., a contingent—rather than, standing—facility; and a prudent level of haircuts to protect BoE capital). Staff views a contingent facility would provide a powerful signal once triggered. - Resilience of MMFs and pension funds: - Staff welcomes FCA regulatory changes proposed for MMFs and stresses international work given the large number of non-UK domiciled sterling MMFs. - Reforms to unlock pension savings for higher-return investments are welcome but should not undermine financial stability; asset allocation should not be mandated and reforms should not hinder fiduciary responsibilities. - Monitoring of DB pension fund buy-outs and potential concentration risk in the insurance industry, including implications for gilt demand, is important. - Staff continues recommending that The Pensions Regulator (TPR) be given an explicit financial stability remit, accompanied by reinforcement of its staffing. - Encouraged: consider expanding auto-enrollment and raising the minimum pension contribution in the medium term. - Data gaps: - Progress on closing data gaps slower than expected (e.g., data on all Sterling asset holdings; liquidity management data by fund managers; flow-of-funds data including cross-border NBFI exposures). - Important to maintain domestic and international momentum to close NBFI data gaps and understand financial stability implications of NBFI leverage. - Staff looks forward to assessment on private equity and interconnected markets to be published in the June 2024 FSR. - Note: recent high interest rates have put pressure on private equity funds, weighing down asset valuations; a sharp reduction in asset prices could reduce collateral values, increase liquidation demand, trigger losses for NBFIs and banks, and tighten financial conditions. Lack of transparency around asset valuations, leverage, and interconnectedness complicates risk assessment. ### Structural Financial Sector Reforms and Resolution Tools - Structural reforms are progressing cautiously: - Edinburgh Reforms package (December 2022) and Chancellor's Mansion House speech (July 2023) set out regulatory priorities. - Government has taken steps on the 31 initiatives in the Edinburgh Reforms and has preserved the primacy of financial stability objectives. - Enhancements to special resolution regime under development: - Proposal to allow the Financial Services Compensation Scheme (FSCS) to provide funds to the BoE to recapitalize and secure operational continuity of a failing small bank through resolution and then recoup costs through industry levies. - Staff encourages prefunding the FSCS to an appropriate level to avoid moral hazard. ### AML/CFT, Transnational Corruption, and Supervisory Effectiveness - Authorities continue to strengthen AML/CFT risk-based supervision given the UK’s high exposure to laundering of proceeds of foreign crimes. - Recommended continuation of measures under Economic Crime Plan 2023–26 to improve effectiveness and coordination of the AML/CFT supervisory regime, including HMT consultations on potential changes to the Money Laundering Regulations and implementation of a data framework to measure supervisor effectiveness. - FCA continues implementing a proactive, data-driven supervisory strategy covering systemically important entities more frequently. - To prevent criminal use of virtual assets, FCA pursues a stringent risk-based approach to registration and supervision of virtual asset service providers. - Economic Crime and Corporate Transparency Act (passed October 2023) provides broadened powers for law enforcement for quicker seizure and recovery of virtual assets that are proceeds of crime. - Voluntary Assessment of Transnational Aspects of Corruption (Box 1) highlights: - UK faces significant foreign bribery risks but has continued mitigation efforts. - OECD Phase 4 evaluation acknowledges consistent enforcement efforts and provided recommendations. - Authorities should continue implementing OECD Phase 4 recommendations (whistleblower protection, resources for foreign bribery enforcement, independence of investigation and prosecution, transparency of court decisions, engagement with CDs and BOTs). - Economic Crime and Corporate Transparency Act 2023 introduces reforms to strengthen beneficial ownership transparency and targets high-risk limited partnerships. - Authorities continue engagement with UK Overseas Territories and Crown Dependencies on publicly accessible beneficial ownership registers. - Authorities should address deficiencies in risk-based supervision of legal and accountancy sectors; public consultation and reform options are under assessment. - Professional enablers strategy developed to improve intelligence sharing between private sector, supervisors, and law enforcement. - Authorities should continue efforts to strengthen entity transparency and effective supervision of high-risk sectors. ### Authorities’ Views on Financial Stability and NBFI Workstreams - Authorities noted financial stability environment somewhat calmer than last year. - FPC reiterated UK banking system resilience and robust prudential supervision; careful progress on Strong and Simple regime by PRA. - FPC viewed macroprudential settings as appropriate; credit conditions overall reflect macroeconomic changes rather than defensive bank actions. - BoE completed the first round of SWES; final results expected to be published in 2024Q4. - BoE plans to launch a new NBFI repo facility; work underway to determine key design features. - FCA described industry feedback on enhancing liquidity management of UK-domiciled sterling MMFs as broadly positive and believed market could adjust to proposed requirements. - Authorities noted ongoing domestic and international work to close NBFI data gaps. ### Climate Policies and Recommendations - Recent relaxation of climate policies and decline in the UK carbon price will put the UK’s ambitious climate targets further off track. - Context and key figures: - UK adopted an NDC to reduce emissions by 68 percent by 2030, having already reduced emissions by 50 percent below 1990 levels. - UK accounts for around 1 percent of global emissions. - In September 2023, government announced exemption for 20 percent of homes from requirement to transition to electric heat pumps and delayed transition deadline for homes off the gas grid from 2026 to 2035. - Transport: requirement that 80 percent of new vehicles sold in the UK be ‘zero emission’ by 2030 (100 percent by 2035) is in legislation, but ban on purchasing internal combustion engine vehicles delayed from 2030 to 2035. - UK carbon price has declined to around 50 percent of its level in early 2023, and is well below the corresponding EU price. - Announcement of a UK CBAM, to be implemented from 2027, is welcome. - Net impact: existing policies are only sufficient to achieve 57 percent of the UK’s NDC emissions reduction target by 2030. - Policy recommendations: - Stay the course on climate policy to maintain status as a climate leader and realize benefits of the green transition. - Whole-of-economy investment in the green transition should increase to £50 billion pounds per year by 2030 (from £20 billion in 2020), with a public contribution of around one third. - Public support to households for transition from gas heating to electric heat pumps is a priority given buildings sector is among largest contributors to UK emissions. - Exemption for certain homes from heat pump requirement should be narrowly defined; relaxation of energy efficiency requirements for rental properties should be reversed. - Consider strengthening feebates on heating options for non-exempt homes in the near-term (with taxes on new fossil fuel heating funding subsidies for heat pumps). - With delay of purchase ban to 2035, consider stronger price-based incentives for zero-emission vehicles (larger feebates; higher taxes on internal combustion engine vehicles supporting non-discriminatory consumption subsidies for electric vehicles), consistent with WTO rules and without favoring local manufacturers. - Implement CBAM in line with WTO rules, basing charges on actual carbon content in traded products rather than benchmarks. - Consider widening ETS coverage to include road transport and buildings (or consider upstream carbon taxes in these sectors), supported by a fixed carbon price floor that rises over time. - Pursue long overdue action on agricultural emissions by implementing a self-reporting regime for farmers, with emissions subject to a fee. *Source: United Kingdom — selected sections on Authorities’ Views, Financial Sector Policies, and Climate Policies.* ### 47. Authorities’ Views. The authorities explained the UK’s strong performance in reducing ### Authorities’ Views and Staff Appraisal ### Authorities’ Views on Climate and Energy - Emissions have been halved relative to 1990 levels. - The first three carbon budgets have been met, subject to the UK’s strong legal framework for climate policy. - Recent changes to climate policy (e.g., delaying the ban on purchase of internal combustion engine vehicles) bring the UK more into line with peer countries. - Legislative passage of the Electric Vehicles (EV) mandate requiring 80 percent of new vehicles sold in the UK to be fully electric by 2030. - Uptake of EVs is progressing well. - Conversions to heat pumps for home heating have accelerated, albeit from a low base, since the Boiler Upgrade Grant was increased. - A net-zero consistent cap on emission trading scheme allowances has been implemented; authorities believe this will be sufficient to support an appropriate carbon price in the UK. - Authorities note the important role of public investment in the green transition and public-private cooperation, particularly in the power sector. - Future public spending levels will be set at the next Spending Review. ### Macro Outlook — Growth, Inflation, External Position - Real GDP growth forecast: 0.7 percent in 2024 and 1.5 percent in 2025. - Disinflation has advanced faster than expected, with a durable return to the target forecast by early 2025, contingent on wage growth and services inflation pressures abating. - Longer-term growth prospects remain subdued due to weak labor productivity and somewhat higher-than-expected inactivity levels, only partly offset by higher migration numbers. - Risks to growth and inflation are balanced. - The 2023 external position was weaker than the level in line with fundamentals and desirable policies. ### Monetary Policy and Quantitative Tightening (QT) - Bank Rate is more than 2 ppts. higher than staff’s estimate of the neutral rate. - Next phase of monetary policy is to ease. - Rate cuts of 50–75 bps in 2024 would balance the risks of premature and delayed easing, but a meeting-by-meeting approach remains appropriate given uncertainties. - Given a possible divergence from the Fed, there will be a premium on effective MPC communications; a press conference after each rate decision would be beneficial. - Reduction in the APF’s gilt holdings through QT and the redemption of TFSME could lead the level of reserves to approach the estimated range for the BoE’s steady-state balance sheet size as soon as 2025H2. - Articulating a clear rationale for future QT plans will be important. - In implementing recommendations from the Bernanke review, consider including, in any “alternative scenarios”, scenario-specific monetary policy paths generated by BoE staff and allocate adequate resources to enhance and maintain required modeling infrastructure. ### Fiscal Outlook and Policy Choices - Staff’s analysis suggests accommodating pressures in key public services and critical growth-enhancing investment needs, including for the green transition, will imply a non-stabilizing public debt to GDP ratio over the five-year projection horizon. - Debt stabilization will require the primary balance to be, on average, around 0.8 ppt. GDP higher per year (relative to staff’s baseline) which, absent a major boost to potential growth, will necessitate difficult tax and spending choices. - Possible revenue measures: - Raising additional revenue from higher carbon and road-usage taxation. - Broadening the VAT and inheritance tax bases. - Reforming capital gains and property taxation. - Possible spending-side measures: - Indexing the state pension (only) to increase the cost of living. - Expanded/enhanced charging for public services, while taking care to protect the vulnerable. ### Fiscal Framework Strengthening - Recommendations: - Strengthen the debt rule with the requirement that debt be falling by the fifth year with a high probability (e.g., 75 percent) to increase fiscal buffers. - Produce 4–5 year expenditure frameworks every two years, replacing the non-rolling 3-year spending reviews. - Require that an OBR forecast accompany each fiscal event. - Extend the OBR’s forecast horizon for its Economic and Fiscal Outlooks to ten years to better capture longer-term spending pressures and dividends from growth-enhancing measures. - Move to one fiscal event per year to steady decision making and reduce political pressure points for fiscal loosening. - Adjust the treatment of QE/QT profits and losses in future cycles with a view to protecting the BoE from political pressures. ### Policies to Boost Potential Growth - Past helpful measures include investment tax reliefs for businesses, expansion of childcare, and active labor market policies, but these are unlikely to lift long-term potential growth to pre-GFC levels. - Additional ambitious reforms needed in: - Easing planning restrictions. - Upskilling the workforce. - Improving health outcomes. - Reforms should be nested within a stable, long-term growth strategy backed by an independent growth commission to coordinate across levels of government and track implementation (akin to the Climate Change Committee). - Continue a cautious approach to industrial policy while maintaining an open trade orientation. ### Climate Policy Priorities - The UK has halved emissions relative to 1990 levels, but current policies and spending allocations are insufficient to meet the 2030 target. - Key priorities: - Ensuring the needed level of investment for the green transition. - Enhancing incentives for conversion to electric vehicles and heat pumps through the use of feebates. - Strengthening the UK’s emission trading system and eliminating the shortfall of the UK carbon price below the EU price. - Implementing the UK’s CBAM in a way that minimizes administrative burdens on importing firms. ### Financial Stability and Supervision - Financial stability risks have been contained thus far; continued strong supervision of all banks and NBFIs is warranted. - Households and corporates have been resilient, supported by strong wage growth and enhanced regulatory measures. - Other risks to monitor: - Globally stretched valuations across asset classes (notably private equity). - Spillovers from CRE stress in other jurisdictions. - Capital and liquidity positions of major UK banks remain robust. - Diverse business models of smaller banks merit continued close monitoring, including through stringent stress tests. - BoE initiatives in the NBFI space include a system-wide exploratory scenario exercise and the design of a BoE backstop lending tool for non-banks. - Importance of maintaining domestic and international momentum to close data gaps and reduce NBFI vulnerabilities. ### Structural Financial Sector Reforms - Edinburgh reforms have proceeded carefully and preserved the primacy of financial stability objectives. - Support for government’s plan to reform the special resolution regime to minimize disruptions from small bank failures, with encouragement to prefund the FSCS to an appropriate level to avoid moral hazard. - Caution warranted around possible financial stability implications of the pension reforms, given ongoing DB pension fund buy-outs and potential concentration risk in the insurance industry. - Encourage expanding auto-enrollment efforts and raising the minimum contribution to ensure adequate pensions for employees. - Continue to strengthen the effectiveness of AML/CFT risk-based supervision. *Source: IMF staff and authorities’ views as presented in the provided content unit.* ### 56. It is recommended that the next Article IV consultation be held on the standard ### 56. It is recommended that the next Article IV consultation be held on the standard ### Real sector developments - Real private consumption remains subdued (Real Consumption: Index, 2019Q4=100). - Household savings rate remains high relative to pre-COVID level (Household Income, Balance Sheet and Savings Rate: LHS Index, 2019Q4=100; RHS percent). - Private investment has been weak (Real Fixed Investment: Index, 2019Q4=100). - Price pressures have declined faster than expected (CPI Trimmed Mean: Y-o-y percent change; data referenced through Apr-24). - Wide dispersion of inflation across sectors remains (CPI Dispersion: Y-o-y percent change, SA; Median, 25th Percentile, 75th Percentile series shown through Apr-24). - Inflation expectations have eased since mid-2023 (Inflation Expectations derived from RPI based swaps; note: Historically, RPI is 1 ppt higher than CPI). Specific series shown: 5y5y, 5y2y, 5y (Jan-20 to Apr-24). ### Labor market indicators - Firms’ employment expectations suggest cooling (Firms’ Sales and Employment Expectations: Percent growth rate; series Jan-21 to Apr-24). - Firms’ expectation of capital expenditure has declined (Expectation of Capital Expenditure Authorizations: Percent balance, over next year vs. last year; CBI series up to Jun-24). - Labor demand has cooled (Labor Demand: Index, 50+ = increase; Index of Demand for Staff and components through Apr-24). - Staff pay rates are moderating (Permanent Staff Salaries and Temp Staff Pay Rates: Index, 50+ = increase; series through Apr-24). - Overall staff availability improved while permanent staff placements have declined across sectors (Overall Staff Availability: seasonally adjusted, 50+ = increase; Permanent Staff Placements by Sector: Construction, Nursing & Medical Care, Hotel & Catering, Blue Collar, IT & Computing, Accounting & Financial; series through Apr-24). - Sources cited: S&P Global; Bank of England Decision Making Panel; Haver Analytics. ### External sector developments - Current account deficit widened marginally in 2023 (Current Account Balance: Percent of GDP; series 2005–2023). - Worsening driven by a deterioration in the income balance (Primary Income Balance: Percent of GDP; components include Investment Income: Credits/Debits and Other Primary Income). - Financial account remains very volatile, reflecting large stock positions (Financial Account Balance: Percent of GDP; components FDI, Portfolio Investment, Derivatives, Other Investment; series 2005–2023). - NIIP worsened, largely driven by valuation effects including exchange rate appreciation (NIIP (% of GDP) with NEER and REER indexes; series 2005–2023). - Terms of trade improved sharply in 2023 reflecting lower energy prices (Terms of Trade: Index, 2017 = 100; series 2017–2029 shown). - Trading partner demand was weak (Trade Partner Demand Weighted by Exports: Y-o-y percent change; series 2017Q1–2027Q1). - Sources cited: Haver Analytics; ONS; IMF staff calculations; World Economic Outlook. ### Fiscal developments - Frozen personal income tax thresholds are causing fiscal drag and boosting revenue (Bottom Marginal Tax Threshold (Personal Allowance): GBP; historical series from 1990/91 onward cited). - Spending pressures are mounting including from ageing, with the Triple Lock policy increasing the state pension above inflation (State Pension: FY11 = 100). - Public sector net debt is lower than the median for the G7 but headroom vis-à-vis fiscal rules (deficit and debt targets) has shrunk (Public Sector Net Debt: Percent of GDP; comparative WEO series for France, Germany, United States, United Kingdom, Italy, Japan, Canada). - Successive forecasts show shrinking headroom against fiscal targets (Successive Forecasts for Headrooms Against Fiscal Targets: £ Billion; sources OBR). - Debt interest spending surged due to tight financing conditions and a high share of inflation-indexed bonds and remunerated reserves (Debt Interest Spending Relative to GDP and Revenues: Percent; March 2024 Forecast and Nov 2023 Forecast series). - Composition of central government wholesale debt stock presented (GBP amounts over time). - Sources cited: HM Revenue and Customs; ONS; OBR Economic and Fiscal Outlook, Mar 2024; IMF staff calculations. ### Residential real estate developments - Mortgage rates declined since the peak after the 'mini-budget' (Mortgage Rates: Percent; UK pound 2y and 5y interest rate swaps and 2y/5y 75% LTV fixed-rate mortgage series through Apr-24). - UK rental prices rose at a new record in the year to March (House Prices and Rental Prices: Y-o-y percentage change; Nationwide Building Society House Price Index and Index of Private Housing Rental Prices series). - High interest rates continue to put pressure on debt servicing obligations, which are projected to increase (Aggregate UK Household Mortgage Debt-Service Ratio: Percent). - New mortgage lending in the highest LTV category remains low; lending at LTVs between 90 to 95 percent has increased (New Mortgage Loans as Percent of Gross Advances: Loan to Value: Percent; series 2008–2024). - Lending at high LTI ratios has been contained (New Lending to High-LTI Borrowers: Percent; note: High LTI ratio defined as Single Income Multiple Over 400% and Joint Income Multiple Over 300%). - Mortgage arrears peaked in Q4 2023 but remain low compared with pre-GFC levels (Mortgage Arrears: Percent; Loan Balances and Number of Loans in Arrears series). - Sources cited: Bank of England; Haver Analytics; Mortgage Lending Administration Return (MLAR); ONS; Nationwide Building Society. ### Financial sector - Banking sector maintains a comfortable level of capital buffers (Aggregate CET1 Capital Ratio: Percent; series through 2024Q1). - NBFIs (non-bank financial institutions) are growing as an equally important sector with rising shares in corporate lending and consumer credit (Financial Sector – Financial Assets: Trillion £; Loans to UK NFCs: In billion £; NBFI Share in Outstanding Household Credit: Percent; series through 2024Q1). - Data sources: ONS; BoE; BIS; Haver Analytics. ### Key data tables and institutional efforts - Multiple core tables included in the chapter: Selected Economic Indicators (Table 2), Medium-Term Scenario (Table 3), Statement of Public Sector Operations (Table 4), Balance of Payments (Table 5), Net Investment Position (Table 6), Monetary Survey (Table 7), Financial Soundness Indicators (Table 8). - Anti-corruption and corporate transparency developments (Table 9, Authorities’ Self-Assessment): - Economic Crime and Corporate Transparency Act 2023 (Royal Assent on 26 October) reforms include identity verification for directors and People with Significant Control; broader Registrar powers; improved financial information on register; enhanced investigation and enforcement powers; protection of personal information; measures addressing misuse of corporate entities and reforms to limited partnerships (registration, connection to the UK, transparency, deregistration powers). - Work with Overseas Territories: Gibraltar introduced a fully publicly accessible register in 2020; some OTs expected to follow in 2024; most inhabited OTs agreed interim publicly accessible registers with legitimate interest access filter; UK providing technical and financial assistance. - Engagement with Crown Dependencies: CDs published updated commitments in December 2023 to deliver obliged entity access during 2024 and develop legitimate interest access with proposals for LIA definition to be presented by Q4 2024. - OECD Working Group on Bribery: UK reported progress in June 2023; WGB agreed not to ask for further updates on six priority recommendations. - New UK Anti-Corruption Strategy is under development with publication expected shortly. - International anti-corruption actions: International Development White Paper (November 2023) with 8 commitments; active role at the 10th COSP to UNCAC (December 2023); use of sanctions including Global Anti-Corruption sanctions (7 delegations since last report; sanctions on 3 Ugandan Parliamentarians on 30 April); Global Call to Action for company ownership transparency with £2m funding to World Bank and IMF Trust Funds; support for G7 commitment to establish 15 Beneficial Ownership registers in Africa via Africa Beneficial Ownership Transparency Network. - Sources for these institutional items: text contained in Table 9 and subsequent concluded section. *Sources: Bloomberg Finance L.P.; IMF staff calculations; ONS; Haver Analytics; S&P Global; Bank of England; CBI; HM Revenue and Customs; OBR; World Economic Outlook; BIS.* ### Annex I. Preliminary External Sector Assessment ### Annex I. Preliminary External Sector Assessment ### Overall Assessment and Policy Responses - Overall assessment: The external position in 2023 was weaker than the level implied by medium-term fundamentals and desirable policies. - 2023 drivers: CA deficit deteriorated marginally in 2023, reflecting a higher income deficit largely offset by improved trade balances due to lower energy prices and a negative public imbalance. - Projection: The CA deficit is projected to gradually narrow as trade balances recover. - Uncertainty: Significant uncertainty due to measurement issues and the evolving impact on trade and capital flows of the new EU-UK Trade and Cooperation Agreement. - Potential policy responses: - Gradual fiscal consolidation, while preserving key public services and protecting the vulnerable, to help close the CA gap. - In the medium term, implement structural reforms to boost UK international competitiveness (including upgrading the labor skill base to support labor reallocation to fast-growing sectors). - Accommodate a need for rising public investment in support of the climate transition. - Continue to support an open trade environment, including addressing remaining barriers to trade with the EU. - Deploy industrial policies cautiously and targetedly where externalities or market failures prevent effective market solutions. ### Foreign Asset and Liability Position and Trajectory - Background: - NIIP deteriorated to –31 percent of GDP in 2023 from –14 percent of GDP in 2022. - A negative valuation effect (including sterling appreciation) led to the sizable worsening of the NIIP in 2023 in addition to the CA deficit. - Other investment: 196 percent of GDP in assets and 194 percent in liabilities (mainly cross-border bank loans). - Portfolio investment: 123 percent of GDP in assets and 130 percent in liabilities. - Geographic composition: Other European countries, Japan, and the United States account for about three-quarters percent of total UK external assets and liabilities. - External liabilities have a larger share denominated in pounds than do external assets. - IMF staff projection: NIIP will moderately improve over the medium term, although large and volatile valuation effects make estimates particularly uncertain. - Assessment: - Despite large valuation losses in 2023 (mainly on other investment assets), total valuation gains since 2016 (including unrecorded impacts) have more than offset negative CA flows on the NIIP. - Fluctuations in large gross stock positions could be a potential source of vulnerability (gross assets and liabilities exceed 500 percent of GDP). - The UK’s net liability position in domestic currency and exchange rate flexibility would offer some insurance against external crises. - Key 2023 stock numbers (percent of GDP): - NIIP: –31 - Gross Assets: 503 - Debt Assets: 257 - Gross Liab.: 534 - Debt Liab.: 282 ### Current Account - Background: - CA deficit increased from 3.1 percent of GDP in 2022 to 3.3 percent of GDP in 2023, driven by a larger income deficit largely offset by an improved trade balance with a positive terms-of-trade shock. - The 2023 CA deficit (3.3 percent) was higher than the five-year (2019–23) average of 2.5 percent. - Income balance deterioration in 2023 likely due to higher interest payments on pound-denominated external debt. - Decline in investment was slightly lower than the decline in gross savings; public dissaving was 6 percent of GDP and private saving was 2.7 percent of GDP. - Assessment (EBA and staff): - EBA CA model norm: –0.4 percent of GDP. - 2023 cyclically adjusted CA: –3.3 percent of GDP. - EBA Gap: –2.9 percent of GDP. - Measurement adjustments: unrecorded inflation-differential-related valuation effects would otherwise improve the 2023 CA by 0.6 percent of GDP; retained earnings on portfolio equity assets would otherwise worsen the 2023 CA by -0.1 percent of GDP. Together these underestimate the underlying CA by 0.5 percent of GDP. - Staff-adjusted CA gap: –2.4 percent of GDP, within a range of –1.4 to –3.4 percent of GDP. - Key 2023 CA numbers (percent of GDP): - CA: –3.3 - Cycl. Adj. CA: –3.3 - EBA Norm: –0.4 - EBA Gap: –2.9 - Staff Adj: 0.5 - Staff Gap: –2.4 ### Real Exchange Rate (REER) - Background: - Pound appreciated in real effective terms in 2023 by 2.5 percent relative to its average level in 2022, driven partly by nominal appreciation with higher for longer policy rates expected in the UK. - Since mid-2016, the pound has depreciated by about 3.7 percent, reflecting market expectations of more restricted access to the EU market under post-Brexit trade arrangements. - As of April 2024, the REER had further appreciated by 2.8 percent compared to the 2023 average. - Assessment: - The EBA REER level and index approaches suggest a gap of 4 and –6 percent, respectively, for 2023. - Consistent with the staff CA gap, staff assessed the REER gap to be in the range of 5.4 to 13 percent with a midpoint of 9.2 percent (applying an estimated elasticity of 0.26). ### Capital and Financial Accounts: Flows and Policy Measures - Background: - As an international financial center, portfolio investment and other investment are key components of the financial account. - In net terms, the CA deficit was mainly financed in 2023 by net other investment of 11.1 percent of GDP, while net portfolio investment and FDI declined by 6.2 and 2.7 percent of GDP, respectively. - Assessment: - Large fluctuations in capital flows are inherent in countries with a large financial sector; this volatility is a potential source of vulnerability, mitigated by a robust financial stability framework. ### FX Intervention and Reserves Level - Background: - The pound has the status of a global reserve currency. - The share of global reserves in sterling has not changed materially since 2015, at about 4.6 percent. - Assessment: - Reserves held by the UK are typically low relative to standard metrics, and the currency is free floating. *Italicized source attribution line.* ### 7. In line with the above, long-term potential output growth for the UK is estimated at ### 7. In line with the above, long-term potential output growth for the UK is estimated at ### Key finding on potential growth - Staff estimate of long-term potential output growth for the UK: 1.3 percent. - This represents a markdown from 1.5 percent assumed in recent Article IV consultations, primarily driven by reassessment of labor productivity growth due to weaker MFP and capital deepening assumptions. - Given strong migration, potential growth is likely to be higher (closer to 1.5 percent) over the next few years. - Staff’s new path for potential growth is: - Lower than the OBR’s assumptions, particularly in 2028 and beyond, due to lower labor productivity and labor supply growth assumptions. - Stronger than private sector estimates, which range from 1 to 1.3 percent. - Stronger than the BoE’s supply side stock-take in February (which did not reflect latest ONS population projections). - In line with the Euro Area (1.2 percent) and other large European economies: Germany 0.7 percent, France 1.3 percent, Italy 0.8 percent, Spain 1.6 percent. - Lower than Australia 2.3 percent, Canada 1.7 percent, and the US 2.1 percent. ### Table III.1 — United Kingdom: Potential Growth (annual percent) - IMF: 2024 1.4; 2025 1.5; 2026 1.5; 2027 1.4; 2028 1.3; 2029 1.3 - WEO (Jan): 2024 1.6; 2025 1.5; 2026 1.5; 2027 1.5; 2028 1.5; 2029 1.5 - OBR (Mar): 2024 1.6; 2025 1.7; 2026 1.6; 2027 1.6; 2028 1.6 - BoE (Feb) /1: 2024 1.0; 2025 1.2; 2026 1.3 - Footnote: The ONS's updated population projections were not reflected in the MPC's February supply-side stock take. BoE's May MPR projections are conditioned on the most recent ONS population projections with gives an average supply growth of 1½ percent over the next three years. ### Drivers of lower potential: labor productivity and capital - Long-run reassessment attributes weaker potential to: - Weaker Multi-Factor Productivity (MFP) growth. - Weaker capital deepening (slower capital stock growth relative to hours worked). - Historical context for MFP weakness: - Pre-GFC MFP gains were influenced by expanding North Sea oil production in mid-2000s, a large expansion in financial services driven by leverage, and elevated MFP in information and communication during the tech-boom of the early 2000s. - Post-GFC, MFP growth has remained weak over the past decade, in part due to declining firm dynamism; the UK stands out relative to peers. - Investment trends: - Capital accumulation was robust pre-GFC but almost halved in 2008–2010. - Since then, capital stock has grown slower than hours worked. - Business investment remained subdued until recently, affected by post-2016 Brexit uncertainty and the pandemic. - Public investment has not offset weak private investment given a more austere fiscal environment. ### Labor supply dynamics and implications - Labor force growth history: - UK labor force grew faster than peers historically, driven by higher participation among women and older workers, and high worker migration, particularly from Central and Eastern Europe. - Labor composition shifted toward higher skills with a higher share of workers with an advanced degree, supporting labor composition gains. - Recent and future trends: - Growth in labor supply during the 2010s has plateaued; inactivity increased due to long-term sickness. - Short-term migration pickup should support growth, but long-term headwinds include population ageing, increasing dependency ratio, and shifts toward age groups who work shorter hours on average. - Note on 2024 markdown: - The larger markdown in 2024 reflects that the previous figure already incorporated post-COVID normalization and stronger migration in 2023-2024 but did not incorporate the negative surprise from still high and increasing inactivity levels due to long term illness. ### Risk considerations affecting potential growth - The Risk Assessment Matrix identifies global and domestic risks that could lower growth or affect inflation and financial stability (summarized themes): - Global risks: intensification of regional conflicts, surging energy prices, deepening geo-economic fragmentation, abrupt global slowdown. - Domestic risks: systemic financial instability, failure of demand to pick up and monetary policy miscalibration, second-round effects from falling energy prices, lingering Brexit transition problems, cyberthreats, social discontent. - Policy recommendation themes tied to risks (from the RAM): - Consider targeted energy support with clear sunsetting; accelerate green transition and diversify energy sources. - Diversify energy production and secure supply chains. - Let automatic stabilizers operate; provide targeted fiscal support that does not undermine debt sustainability. - Adjust monetary policy as needed to anchor inflation expectations and return inflation to target in a reasonable timeframe. - Ease macroprudential policy (for example, releasing the CCyB rate) if financial tightening exacerbates credit downturns, with targeted liquidity provisions. - Build cyber resilience and ensure large companies have detailed incident response and recovery plans. - Expand support to most vulnerable households and address public service delivery challenges, especially healthcare. ### Labor Force Survey (LFS) quality, response rate, and implications for analysis - Response rate deterioration: - Long-term downward trend in the LFS response rate accelerated during the pandemic. - October 2023 response rate hit a historical low of 12.7 percent (Between July and September 2023, 14,180 households responded from a total of 111,281). - ONS suspended publication of official labor market statistics derived from the LFS due to quality concerns and resumed in February 2024, classifying LFS data as “official statistics in development” until further review and accreditation. - Consequences of low response rates: - Lower response rates increase sampling variability (more volatility) and risk of self-selection bias (less accuracy). - More frequent data revisions are likely as LFS undergoes reweighting to incorporate latest population estimates. - This raises cautions for macro-critical analyses that rely on LFS, including gauging inflationary pressures and informing monetary policy. - ONS response and the Transformed LFS (TLFS): - ONS recovery plan has shown some impact on response rates. - ONS is replacing the LFS with the Transformed LFS (TLFS), developed since before the pandemic and run in parallel with the LFS since 2023. - TLFS improvements: larger sample size and use of additional collection methods (including online collection). - TLFS expected to replace LFS in September 2024, subject to quality criteria being met. - Recommended considerations for ONS (staff recommendations): - Launching the TLFS is a major modernization step and requires more dedicated resources to prevent further delays experienced since 2023. - Offer transparent and timely communication managing rising scrutiny as LFS undergoes major changes and quality concerns. - Consider making LFS participation mandatory (requires legislative change): independent reviews noted compulsory participation tends to be associated with higher average response rates; however, voluntary surveys can sometimes achieve higher response rates at higher cost. - Cross-country perspective on response rates: - Voluntary vs compulsory participation: a simple estimate between 2013 and 2023 showed average response rates close to 60 percent for voluntary participation and 80 percent for compulsory participation, indicating mandatory schemes may raise participation. - Pandemic impacts varied by country; some with high shares of remote collection saw limited drops in response rates. *Source: IMF staff analysis and annexes from the United Kingdom staff report (provided content).* ### Annex VII. Fiscal Implications of Post-Pandemic Large-Scale Asset ### Annex VII. Fiscal Implications of Post-Pandemic Large-Scale Asset Purchases by the Bank of England ### Context and motivation - The fiscal effects of conventional monetary easing are generally favorable because easier monetary conditions reduce debt servicing costs, boost aggregate demand, and increase tax revenues. - Fiscal implications of large-scale asset purchases (LSAP) are less clear because LSAPs can adversely affect central bank profits, especially if policy normalizes earlier than expected. - The UK relied heavily on LSAPs during the Covid-19 pandemic: purchases worth around 17.5 percent of annual GDP for the pandemic wave, on top of post-GFC purchases cumulatively worth around 20 percent of annual GDP. - Global supply chain disruptions and a spike in energy prices following Russia’s invasion of Ukraine prompted faster monetary normalization, with the policy rate quickly rising and eventually exceeding 5 percent. ### Model, calibration, and scenarios - Methodology: - A two-country New Keynesian model with bond market segmentation, augmented with detailed fiscal policy and government debt dynamics, calibrated to UK features and initial conditions. - Start with the interest rate at the ELB and impose a large, negative demand shock to simulate a severe global downturn that keeps the interest rate low for a prolonged period. - Compare macroeconomic and fiscal outcomes depending on whether the BOE undertook extra LSAPs. - Key scenario assumptions: - Baseline LSAP scenario: additional LSAPs implemented at low policy rates. - Earlier-tightening scenario: about 1.5 years after LSAPs, positive demand and negative supply shocks (capturing post-pandemic recovery and sharp increase in energy prices) trigger faster global recovery and an earlier, sharper rise in the policy rate. ### Main quantitative findings - Macroeconomic channel: - By lowering long-term rates, LSAPs mitigated the contraction in economic activity and deflationary pressures, creating room for a slightly earlier policy lift-off. - Fiscal outcomes (preserving exact magnitudes reported): - If the recovery proceeded as forecasted at the time of the additional LSAP, the net fiscal stance would have been favorable, implying a reduction in government debt of around 2 percent of annual GDP at the 8-year horizon. - This positive fiscal outcome stems mainly from increased tax revenues and lower debt service costs, which more than offset lower central bank profits that cumulate to around 4 percent of annual GDP. - Earlier monetary tightening scenario: - LSAPs make the central bank balance sheet more vulnerable to earlier policy normalization. - In the simulated scenario with earlier policy tightening, the cumulative decrease in central bank profits due to LSAPs amounted to about 6 percent of annual GDP. - As a result, ex post fiscal gains from LSAPs were significantly reduced, though the simulations still indicate the overall medium-run impact on public debt remained likely favorable, albeit small. ### Policy implications and comparison with fiscal stimulus - Overall assessment: - The last wave of LSAP by the BOE had favorable effects on the fiscal stance, even accounting for earlier-than-expected monetary policy normalization. - Comparison to fiscal stimulus: - A fiscal stimulus that provided a similar boost to economic activity would clearly increase the medium-run level of government debt, at least for realistic values of fiscal multipliers. *Source: IMF staff calculations.* ### 4. Risks and mitigating factors. The Debt Fanchart and GFN Financeability modules both ### 4. Risks and mitigating factors ### Debt Fanchart and GFN Financeability assessment - The Debt Fanchart and GFN Financeability modules both signal moderate risk. - For the fanchart: - Reflects high uncertainty (as indicated by the fanchart width). - Indicates a high probability of debt non-stabilization. - Shows more moderate end-projection debt levels when adjusted for institutional quality. - Moderate GFN Financeability risk reflects: - Moderately high average GFNs under the baseline projections. - GFNs that exceed 20 percent of GDP in a generalized stress scenario with increased deficits, inflation, lower growth, and a shortening of debt maturities. ### Generalized stress scenario dynamics - In the generalized stress scenario: - Needed (residual) absorption of government debt by domestic banks is further increased by limited rollover of external private financing and continued QT by the BoE. - The absorption only cumulates to 18 percent of sterling-denominated bank assets by end-horizon, owing to the current very low level of government exposure of the banking sector (at about 2¾ percent of sterling-denominated assets). ### Mitigating factors cited - Long maturity of general government debt: - Of about 14 years on average, which smoothes GFNs and limits pass-through from higher yields to effective interest rates. - Lack of foreign currency debt: - Mitigates FX risks. - Substantial market absorption capacity for gilts: - Aided by the UK's large institutional investor base and the sterling's status as a global reserve currency, which mitigate liquidity risks. ### Overall risk judgement - While combining the debt fanchart and GFN indices yields a moderate medium-term risk signal, staff assesses overall risks of sovereign stress to be low. *Source: 4. Risks and mitigating factors. The Debt Fanchart and GFN Financeability modules both signal moderate risk.* ### 7. Continue to encourage ### 7. Continue to encourage the conversion of remaining legacy LIBOR exposures of U.K. regulated firms and support foreign efforts to migrate from non-Sterling LIBOR, mindful of the needs of emerging markets users. (FCA, HMT, and BOE) ### LIBOR transition — progress, risks, and international coordination - Time frame: 1–2 years - Findings and status: - "32 of the 35 LIBOR settings have now ceased permanently." - "The FCA has announced end dates for the remaining 1-, 3- and 6-month synthetic US dollar LIBOR settings which are due to cease at end-September 2024." - "The Bank and FCA continue to facilitate public-private partnerships to allow for a market-led transition." - "The Working Group on Sterling Risk-Free Reference Rates moved forward from 2022 with a revised objective to focus on non-sterling LIBOR transition in UK markets and active transition of any legacy contracts using synthetic sterling LIBOR." - "The Working Group continues to operate, with the expectation it will wind down following the cessation of the final synthetic US dollar LIBOR settings at end-September 2024." - "The PRA and FCA’s central LIBOR supervisory programmes have now been wound down, with ongoing monitoring handed over to individual supervisory teams." - "The PRA and FCA supervised firms with the largest and most complex LIBOR exposures have in aggregate less than £31 billion of exposures to synthetic US dollar LIBOR, down from £3 trillion in 2020." - "The FPC Record on 27 March 2024 covered LIBOR transition." - "The Committee welcomed the further reduction in the stock of legacy US dollar LIBOR exposures, and consequently judged that the financial stability risk in the UK associated with US dollar LIBOR had effectively been mitigated (having previously concluded the same for sterling LIBOR in March 2023)." - "The FPC welcomed the fact that the final synthetic GBP Libor setting would cease on 28 March." - "It noted that all remaining synthetic LIBOR settings have planned end dates in 2024 and encouraged participants to maintain momentum on transition efforts to minimise remaining exposures ahead of these dates." - International coordination and standards: - "The Bank, FCA and HMT continue to work closely with other international authorities in monitoring global use of reference rates." - "The FSB’s Official Sector Steering Group has now been wound down, with ongoing monitoring on the use of reference rates falling to the BIS Markets Committee (escalating to the FSB’s Standing Committee on Supervisory and Regulatory Cooperation as necessary)." - "Marking the progress of US dollar LIBOR transition in the US, the Alternative Reference Rates Committee has now been wound down." - "IOSCO published a statement following its review of alternatives to US dollar LIBOR. The review assessed how certain US dollar benchmarks align with IOSCO Principles 6, 7, and 9 relating to design, data sufficiency, and transparency, and whether such rates provide users with robust and reliable benchmarks and sufficient information to enable them to assess their suitability." - "The review highlighted concerns that some credit sensitive rates – marketed as potential substitutes for US dollar LIBOR – exhibit the same inherent “inverted pyramid” weaknesses as LIBOR." - "Bloomberg announced plans to cease its BSBY index in November 2024." *Source: 1gbrea2024001 - 7. Continue to encourage* --- ### 8. Continue preparing for diverse failure scenarios; eliminate rules that may constrain the bank resolution regime; and accelerate and expand the work on recovery and resolution planning for insurers and CCPs. (HMT, BOE/PRA, FCA, and FSCS) ### Banks — resolution preparedness and lessons learned - Time frame: 3–5 years - Findings and work in progress: - "The UK's bank resolution regime has been in place since 2009 and has been iterated over time to ensure it continues to effectively limit risks to financial stability, depositors and public funds." - "The Bank has continued to prepare its HCF execution materials for diverse failure scenarios, including cyber, and use of multiple tools concurrently." - "The Bank is working with HMT as part of its updates to the Code of Practice to consider amendments relevant to the IMF’s recommendations." - "The authorities have worked together to consider any lessons learned from SVB US / UK and CS failures to enhance our approach and engaged with relevant international work, including by the FSB, on lessons learned." - "A key part of this has been the publication by HMT of proposed enhancements to the Special Resolution Regime in January 2024." ### Insurance — new tools and proposed Insurance Resolution Regime - Time frame: 3–5 years - Findings and work in progress: - "The new s377A of FSMA, to give the PRA an additional tool to deal with a failing insurer to facilitate continuity of cover for policyholders has been enacted and is in the process of being fully operationalized by the PRA." - "HMT consulted on establishing an Insurance Resolution Regime (IRR) in January 2023, and have subsequently announced that legislation to implement the new regime will be introduced when Parliamentary time allows." - "The proposed regime will align the UK to relevant standards, providing the Bank as resolution authority with a range of tools and powers to manage the failure of an insurer where this would have adverse systemic impacts." - "When IRR is implemented, it will complement the Insurance Core Principles that the PRA complies with as part of its group-wide supervision of Internationally Active Insurance Groups, by requiring resolution authority-led resolvability assessment and resolution planning for our most systemically important insurers." - "In addition, in January 2024 the PRA issued a Consultation Paper proposing an expansion of the requirements for all UK insurers to prepare for a solvent exit as part of their BAU activities, so that, if needed, they could cease PRA-regulated activities in a timely and orderly manner." - "The PRA intends to publish a Policy Statement on this subject in the second half of 2024, with Q4 2025 as the proposed implementation date for resulting changes." ### CCPs — legislative enhancements and resolution planning - Time frame: 3–5 years - Findings and work in progress: - "In June 2023, new primary legislation that includes an extensive enhancement of the UK’s CCP resolution regime (see Schedule 11 of FSMA 2023) was passed into law." - "Following the putting into place of several pieces of secondary legislation required to bring the enhancements into effect, the new regime entered into effect on 31st December 2023." - "These enhancements made the UK regime fully consistent with FSB standards, providing the Bank with a range of tools and powers that enable it to act quickly, flexibly and decisively to handle the failure of a CCP." - "The Bank is progressing CCP resolution planning and enhancing our operational capacity and preparedness to execute a CCP resolution." - "These arrangements were subject to testing, both internally and with external partners, in 2023 and will continue to be tested in 2024." - "The Bank has commenced development of a CCP RAF program, and this work will continue in 2024." *Source: 1gbrea2024001 - 7. Continue to encourage* --- ### 9. Preserve the primacy of the FPC’s financial stability objective and strengthen its focus on global financial standards and cross-border surveillance. (HMT, BOE, PRA, and FCA) ### Mandate, communications, and international stance - Time frame: 1 year - Findings and actions: - "The 2023 Remit letter from the Chancellor underscores the primacy of the FPC’s financial stability objective and does not add material new responsibilities related to the FPC’s secondary objective." - "It also recommends the FPC support international work to address vulnerabilities in the financial system." - "The FPC has continued to emphasise in its external communications that UK financial stability will require levels of resilience at least as great as those put in place since the GFC and required by international baseline standards, and - recognising the importance of the UK as a global financial centre - in some cases greater." - "The FPC has also publicly stressed the importance for UK financial stability of alignment with international standards within the PRA and FCA’s new secondary objectives." - "The PRA’s September 2022 discussion paper on its approach to policy also noted it will remain at the forefront of efforts to strengthen international standards where necessary, and that the long-term competitiveness of the UK is underpinned by a robust and effective prudential regime, built around global standards, in a way that instils trust and confidence in the UK as a place to do business." *Source: 1gbrea2024001 - 7. Continue to encourage* --- ### 10. Preserve the primacy of PRA and FCA’s objectives of safety and soundness and market integrity, in principle and in practice, over any secondary objectives and ad hoc policy priorities. (HMT and FPC) ### Legal framework and supervisory guidance - Time frame: 1 year - Findings and actions: - "The Financial Services and Markets Act (FSMA) 2023, enacted by Parliament, preserves the primacy of the primary objectives to act in a way that promotes the safety and soundness of PRA-authorized persons so far as reasonably possible and to contribute to the securing of an appropriate degree of protection for those who are or may become policyholders while providing the PRA with wider rule-making responsibilities and enhanced accountability requirements." - "FSMA 2023 gives the PRA a new secondary competitiveness and growth objective. This objective is to facilitate, subject to aligning with relevant international standards, (i) the international competitiveness of the economy of the United Kingdom (including in particular the financial services sector through the contribution of PRA-authorized persons); and (ii) its growth in the medium to long term." - "FSMA 2023 left unchanged the existing PRA secondary objective to facilitate effective competition in the markets for services provided by PRA-authorized firms in carrying on regulated activities." - "The secondary objectives are engaged only when the PRA is proposing to perform its general functions in pursuit of the primary objectives, and do not rank above the latter." - "The PRA’s recent Consultation Paper (CP) 27/23 sets out the approach that the PRA proposes to take to policy under FSMA 2023. The CP makes clear that primary objectives rank above all other considerations when making policy." - "The CP also describes how maintaining trust among domestic and foreign firms in the PRA and UK prudential framework is an important part of the PRA’s approach to advancing its secondary competitiveness and growth objective. The PRA maintains trust by maintaining strong prudential standards." - "The FCA was also given a secondary growth and competitiveness objective by FSMA 2023, maintaining the existing clear hierarchy of objectives." - "Both the FCA and the PRA are required by FSMA 2023 to report on how they are advancing their new growth and competitiveness objectives, and the first reports will be published in 2024Q2." *Source: 1gbrea2024001 - 7. Continue to encourage* --- ### 11. Review and estimate the expected workload in core and new financial stability and supervisory risk areas and determine how to align BOE/PRA and FCA capacity and resources accordingly. (HMT, BOE/PRA, and FCA) ### Resourcing, capability transformation, and technology - Time frame: 1–3 years - Findings and actions: - "Over 2022/23, the PRA increased its funding, re-deployed resources and set up a flexible resource hub to help manage its expanded regulatory responsibilities. The PRA is satisfied, after more than a year embedding, with these improvements." - "They have enabled the organisation to better manage its expanded regulatory responsibilities. However, it recognises that its responsibilities will continue to expand (e.g. as it takes on responsibility for overseeing critical third parties that are designated by HM Treasury under the Financial Services and Markets Act 2023). Therefore, a continual focus on the resourcing model (as well as workflow) will be required to ensure the PRA can continue to regulate effectively." - "The second part of the PRA 2026 strategy includes the transformation of our capabilities around solvent exit planning (complementing the capabilities the authorities have built and continue to build on resolution as outlined in KR8) for small to mid-tier firms and the use of advanced technology to support supervision. As of 2024, this transformation is ongoing." - "On solvent exit planning, the PRA issued two consultations papers (one for insurers, one for deposit takers) to consult on new rules and expectations. It is also considering changes to internal requirements on supervisors later in 2024." - "On deploying new technology, the PRA has released a number of new tools to help its supervisors extract value from existing data. Alongside, it is currently piloting more advanced tools that make use of machine learning and exploring use of automation and artificial intelligence to enhance workflow." - "Lastly, the PRA is continuing to consult with industry (across both banks and insurers) regarding the data it needs (and does not need) to collect in the future to ensure it can continue to supervise effectively." *Source: 1gbrea2024001 - 7. Continue to encourage* --- ### 12. Ensure that the final accountability and transparency mechanisms adopted under the ongoing FRF review seek to safeguard regulatory independence and pose no constraints for operational and oversight effectiveness. (HMT, PRA, FCA with other agencies) ### Accountability, transparency, and rule review arrangements - Time frame: 1–3 years - Findings and actions: - "The Financial Services and Markets Act (FSMA) 2023 includes a range of measures to enhance the regulators’ transparency, accountability and scrutiny. These include rule review, the establishment of a Cost Benefit (CBA) Panel as well as notifying the Treasury Select Committee (TSC) and the newly established Lords Financial Services Regulation Committee when the authorities publish a consultation and respond in writing to parliamentary committees’ formal responses to consultations." - "Importantly, these measures also preserve the regulators’ operational independence." - "Some measures, such as the power for HMT to require regulators to conduct a review of specified rules, or to oblige regulators to make rules in a certain area, or to impose additional ‘have regards’ for rule-making, will require close ongoing cooperation between the regulators and HMT." - "The Bank recognizes the importance of appropriate accountability, greater transparency, and clearly communicating the reasoning underpinning our judgements and the Bank has set this out in our consultation paper Consultation Paper (CP) 27/23." - "FSMA 2023 provides for the establishment of a Cost Benefit (CBA) Panel, composed of external experts. This will enhance independent scrutiny of our cost benefit analysis. The requirement for the regulators to consult the CBA Panel comes into force on 1 August 2024." - "In addition, the Bank has published a statement on how the PRA approaches rule reviews." - "The FCA has also published (in January 2024) its Rule Review Framework and online stakeholder feedback tool to make it easier for anyone to provide evidence about how well rules are working in practice." - "Alongside a new general rulemaking power for the Bank over CCPs and CSDs, new accountability and transparency mechanisms have been created for the Bank’s regulation of CCPs and CSDs which the Bank has begun implementing. These include a statutory committee, a requirement to carry out cost benefit analyses when using the new rulemaking power, a secondary innovation objective and increased engagement with HM Treasury and Parliament." - "The majority of the accountability mechanisms came into force on 1 January 2024, including the new FMI Committee which will govern use of the Bank’s new general rulemaking power in accordance with the FSMA 2023 accountability framework." - "The National Audit Office has recommended that when appropriate, HMT should work with the regulators and other stakeholders to review the effectiveness of the new accountability arrangements. HMT intends to do this at an appropriate point, once an assessment can be made." *Source: 1gbrea2024001 - 7. Continue to encourage* --- ### 13. Accelerate the efforts to close data gaps on NBFI activities, including data on all Sterling asset holdings and data needed to improve the management of liquidity demands by fund managers; continue improving flow-of-funds data including all cross-border NBFI exposures. (FPC, BOE/PRA, and FCA) ### Data collection, integration, and international pilots - Time frame: 3–5 years - Findings and actions: - "On the back of a comprehensive survey of the available data on banks’ exposures to NBFIs, the Bank has submitted a new data request to banks to address gaps in NBFI exposures." - "The ONS primarily rely on the Financial Services Survey (FSS) to collect balance sheet data from NBFIs and is updating the questionnaire to encompass a wider range of institutions and collect more granular data, including new sector counterparty data which separately identifies the rest of the world." - "Whilst preparing the launch of the new questionnaire and the publication of the data via Data Gap Initiative phase 2 template submissions, the ONS is simultaneously working on integrating the data from the new FSS into the National Accounts." - "Lending by non-bank credit grantors accounts for around half of the total stock of consumer credit and was collected by the ONS on behalf of the Bank. The ONS will cease collection in April 2024 at which point data collection will transition to the Bank." - "Once the collection has been transferred in May 2024, the Bank will be reviewing the coverage of the current collection. This review will be completed in conjunction with data received from the FCA, who will be launching a loan-level consumer credit collection (Product Sales Data), currently scheduled to be received from 2025." - "The Bank and ONS will host a Flow of Funds Workshop in the coming months with stakeholders from across a range of government bodies including HM Treasury, the Office for Budgetary Responsibility, and the Financial Conduct Authority. The focus of the workshop is on planned improvements, identifying data requirements for policy needs, and a broader discussion on current data initiatives." - "The Bank is currently working on exploring and understanding gilt market structure further; as part of this, The Bank has collated data on gilt holdings from multiple sources the Bank has access to and have been able to form an initial view of the size of the data gap in this space. Next, the Bank is aiming to explore different avenues that could enable us to address some of the identified gaps." - "The Bank is co-leading the FSB’s Open-End Fund Data Pilot project, which is considering the availability of data to monitor vulnerabilities arising from liquidity mismatch in funds. The FCA is also a member of this project, and is contributing its data towards it." - "The FCA, Bank and HMT are participating in multiple other international workstreams that are considering the adequacy of existing regulatory reporting, the areas where gaps remain, and how those gaps might be addressed in a coordinated, cross-jurisdictional manner. These include recent and current FSB workstreams on data gaps and leverage." - "Domestically, the FCA has been evolving its own reporting requirements under UK EMIR. Enhanced reporting requirements will become applicable from 30 September 2024. This will improve the granularity of the data, especially with regard to commodity derivatives, but will also add new risk-sensitive metrics, such as the reporting of deltas for options and swaptions." - "The FCA is also starting to consider reform its AIFMD reporting framework as part of the SRF transfer of the AIFM Level 2 regulation, though the work remains in its early stages." *Source: 1gbrea2024001 - 7. Continue to encourage* --- ### 14. Strengthen information sharing with relevant third-country authorities, including reviewing the approach to monitor and supervise hybrid cross border transactions, private market activities, and internationally active mixed financial groups. (FPC, BOE/PRA, and FCA) ### Cross-border cooperation, trilateral forums, and supervisory coordination - Time frame: 3–5 years - Findings and actions: - "Good cooperation, information sharing, and collaboration with relevant third country authorities remains a key priority for the UK authorities." - "Various market and supervisory events have provided opportunities to test these relationships and found them to be strong in both 'peace time' and during crises. Communication and information sharing between supervisory teams across jurisdictions remains strong." - "The PRA continues to look for additional opportunities to further build relationships with a large number of third country authorities." - "The PRA have continued to enhance and develop our trilateral relationship with the FRB and ECB on day-to-day and long-term supervisory issues and have identified potential areas for common work, horizon scanning and information sharing on a number of financial and operational resilience issues." - "For example, through the Trilateral group, the authorities have developed a quantitative data collection template on NBFI exposures that seeks to consider counterparty-credit risk on a group-wide basis." - "The PRA have undertaken a number of reviews in coordination with, or with the full participation of, regulators from key jurisdictions on both crystallised and emerging risks including in relation to Archegos, nickel, fixed income financing, crypto products and private equity." - "The authorities have also shared workplans and key areas of supervisory focus for the year ahead." - "The PRA worked closely with key regulatory authorities (FINMA, FRB and ECB) in handling the resolution and acquisition of Silicon Valley Bank and Credit Suisse respectively, further bolstering strong bilateral and multilateral supervisory relationships and ensuring the free flow of information throughout the critical days and weekends preserving the financial stability of the UK." - "As the authorities navigated the volatility post the invasion of Ukraine, the UK mini budget and the more recent SVB and Credit Suisse events the authorities held joint firm monitoring calls with the FRB and SSM, to further assess firms changes in risk profiles, counterparty exposures and overall risk appetite, on a global basis." - "The authorities also continue to share areas of key concerns on a regular basis with the FRB and SSM, including on a desk-based commodity stress test the authorities conducted through the Russia/Ukraine volatility." *Source: 1gbrea2024001 - 7. Continue to encourage* --- ### 15. Maintain the United Kingdom’s commitment to mutual cooperation with the EU, post-Brexit, including intensifying regulatory dialogue to support financial stability and mitigate market fragmentation risks, including the regulatory status of the U.K. CCPs over the long term. (HMT, BOE, and FCA) ### EU cooperation, fora, and equivalence - Time frame: 3–5 years - Findings and actions: - "The UK welcomes the signing of the Memorandum of Understanding on Financial Services Cooperation on 27 June 2023 and the establishment of the Joint EU-UK Financial Regulatory Forum, which held its first meeting in October 2023 and the second in May 2024." - "UK authorities will continue to closely engage with EU authorities through the semi-annual Forum meetings, as well as bilaterally and through multilateral fora." - "HMT granted the EU a package of equivalence decisions in November 2020, including a decision on CCP equivalence, and announced a further decision under the UK Overseas Funds Regime in" *Source: 1gbrea2024001 - 7. Continue to encourage* ### 2024. The Bank has recognized two EU CCPs—Cboe Clear Europe and Eurex Clearing—with ### Annex XIII. Pension Reforms ### Overview - The government announced reforms to direct pension assets toward domestic growth assets to support domestic growth and improve pension outcomes. - Staff finds that, despite being relatively small in terms of total assets, defined contribution (DC) pension funds have greater scope to invest in UK equity provided appropriate investment vehicles are available. - Increasing pension contributions (which remain low in the UK relative to peers) will boost pension income and increase pension funds’ assets for high-growth investment. ### Key reforms announced (Autumn Statement 2023 and 2024 Spring Budget) - Objectives: provide better outcomes for savers, foster a more consolidated pensions market, and facilitate diversified investment portfolios of pension funds. - Main initiatives: - Proposal of a "pot for life" system and merging of smaller pension pots. - Critical evaluation of “master trust” DC pensions. - Exploration of alternatives to buyouts for defined benefit (DB) pensions and new approach to managing pension surpluses. - Consolidation of local government pension schemes. - Emphasis on cost-effectiveness in DC pensions and enhancing trustees’ expertise. - Requirement in 2024 Spring Budget for DC pension funds to publicly disclose their level of investment in the UK and introduction of a new Value for Money framework. - Mansion House compact: largest DC pension funds encouraged to allocate at least 5 percent of their assets in unlisted equity by 2030. ### Pension system structure and assets - Transitioning from DB to DC, but total assets still dominated by DB pension funds. - Reported asset levels: - Private sector DB and hybrid funds: about £1.1 trillion. - Private sector DC and public sector DB funds: £0.7 trillion. - Pension fund assets amounting to roughly 95 percent of GDP at end-2022. - Comparators: US pension assets $35 trillion, 103 percent of GDP at end-2022; Netherlands roughly 180 percent of GDP, $1.8 trillion. - Note: Total pension assets generally do not include public sector unfunded pensions for government employees, teachers, and health workers. ### Asset allocation and trends - Aggregate allocations (OECD, 2022): - 29 percent of assets in equity. - 35 percent in bills and bonds. - DB pension funds: - Equity holdings fell from 61 percent in 2006 to 18 percent in 2023. - Share of UK equities declined from 30 percent to 1 percent. - Asset allocation to bonds grew from 29 percent in 2006 to just under 70 percent in 2022, broken down into: - index-linked bonds 30 percent, - corporate bonds 25 percent, - other government bonds 13 percent. - DC pension funds: - Around half of DC funds' assets are invested in equity versus only 15 percent for private DB funds. - Quarterly flows: equity inflows into DC funds about £3.0 billion per quarter; equity outflows from DB funds £2.5 billion per quarter. - DB funds remain larger than DC funds by a factor of 7, though DB assets are shrinking and DC assets are growing; experts estimate DC assets will be bigger by around 2032 by extrapolating the past four years. ### Drivers of allocation shifts - Asset-liability matching rules and discounting based on corporate bond yields have incentivized DB funds to invest in long-dated debt and fixed income for liability matching. - Aging beneficiary pool increases preference for lower-risk assets. - Regulatory reforms have encouraged reduction in risk and discouraged long-term equity investment for DB schemes. ### Policy considerations and staff recommendations - Do not mandate pension fund asset allocations; preserve fiduciary responsibilities and best outcomes for beneficiaries. - Disclosure and Value for Money framework could increase exposure to UK equities by improving transparency and incentives. - Caution on consolidation: avoid investment limits that could force sales or create unintended market volatility. - Consider gradual increase in minimum contribution rate in the medium term to expand assets available for investment in UK equity and retirement income, potentially via a relatively larger minimum contribution from employers, while considering impacts on precautionary savings of lower-income groups. - Current minimum contribution rate: 8 percent (with employers minimum contribution set at 3 percent and the remainder by staff contribution). - Consider shifting public unfunded pension schemes to an explicitly funded model as a more ambitious reform to alleviate government spending pressures and provide resources for productive investment (experts cite Canada’s transition from the late 1980s as a potential example). ### Implementation details and timeline items from authorities’ announcements - Reduction in authorized surplus payments charge from 35 percent to 25 percent from April 6, 2024. - March 2025 deadline for accelerated consolidation of Local Government Pension Scheme (England and Wales) assets, targeting pools exceeding £50 billion Assets Under Management and implementing a 10 percent allocation ambition for investments in private equity. - Commitment of £250 million to 2 successful bidders in the Long-term Investment for Technology and Science (LIFTS) initiative, subject to final agreement. - Intention to establish a Growth Fund within the British Business Bank; development of a fellowship course for mid-career science and technology Venture Capital (VC) investors to be operational in 2024. ### Potential impacts and monitoring - Reforms could materially affect gilt-market demand and financial stability; staff recommends authorities continue to closely monitor demand for gilts and any adverse market developments given: - the relative share of gilts held by pension funds, - the buy-out of DB pension funds by insurers with different investment preferences, - reforms encouraging DC funds to increase allocation to equities. *UNITED KINGDOM — INTERNATIONAL MONETARY FUND, Annex XIII. Pension Reforms.* ### Annex XIV. Data Issues ### Annex XIV. Data Issues ### Tables Included - Table XIV. 1. United Kingdom: Data Adequacy Assessment for Surveillance - Table XIV.2. United Kingdom: Data Standards Initiatives - Table XIV.3. United Kingdom: Table of Common Indicators Required for Surveillance ### Temporal and Document Details - As of June 13, 2024 - UNITED KINGDOM 102 INTERNATIONAL MONETARY FUND - UNITED KINGDOM INTERNATIONAL MONETARY FUND 103 *Source: 1gbrea2024001 - Annex XIV. Data Issues* ### Annex XV. The Authorities’ Update on Edinburgh Reforms ### Annex XV. The Authorities’ Update on Edinburgh Reforms ### Progress on Edinburgh Reforms — competitive marketplace and capital use - Reforming the Ring-fencing Regime for Banks: In progress - Draft SI published for consultation on 28 September 2023; consultation closed on 26 November 2023. - Call for Evidence on aligning ring-fencing and resolution regimes concluded on 7 May 2023; summary of responses published on 28 September 2023. - Issuing new remit letters for the PRA and FCA with clear, targeted recommendations on growth and international competitiveness: Delivered - Remit letters published on 9 December 2022. - Government launched call for proposals on measuring progress/impact; in December 2023 published a list of metrics that the FCA and PRA will publish from 2024. - Publishing the plan for repealing and reforming EU law using powers within FSMA 2023: Delivered - Policy Statement and illustrative SI published on 3 December 2022. - Overhauling the UK’s regulation of prospectuses: Delivered - Draft SI in December 2022; near final SI in July 2023; final SI laid on 27 November 2023 and approved by Parliament. - Reforming the Securitisation Regulation: Delivered - ‘The Securitisation Regulations 2024’ approved by Parliament in January 2024; ‘The Securitisation (Amendment) Regulations 2024’ approved in May 2024. - PRA and FCA consulted in summer 2024 and published consultation outcomes in April 2024. - Repealing the PRIIPs Regulation and consulting on a new direction for retail disclosure: In progress - Government response published 10 July 2023; draft SI to deliver new UK retail disclosure framework published at Autumn Statement 2023. - Repeal of EU legislation on ELTIF: Delivered - Commencement Regulations made on 10 July 2023. - Short Selling Regulation reforms: Delivered - Call for Evidence published December 2022; response on 11 July 2023. - Consultation on sovereign debt and CDS aspects launched 11 July 2023; response at Autumn Statement 2023. - Draft SI for new UK short selling regime at Autumn Statement 2023. - The Short Selling (Notification Threshold) Regulations 2023 laid on 27 November 2023. - FSM Bill draft SI for FCA rulemaking powers over retained EU payments legislation: Delivered - Draft SI published 4 December 2022; laid 12 July 2023. - Payment Accounts Regulations (PARs) customer information requirements: Delivered - Consultation published 9 December 2022; response June 2023; secondary legislation July 2023. - PRA consultation on capital deduction rules for certain non-performing exposures: Delivered (Government welcomed the PRA consultation). - Wholesale Markets Review secondary legislation: Delivered - Markets in Financial Instruments (Investor Reporting) (Amendment) Regulations 2022 laid 9 December 2022. - Financial Services and Markets Act 2000 (Commodity Derivatives and Emission Allowances) Order 2023 laid 29 March 2023. - Accelerated Settlement Taskforce: Delivered - Taskforce established; Charlie Geffen appointed chair; initial findings requested by December 2023 and recommendations by December 2024; report expected in Spring 2024. - Independent Investment Research Review: Delivered - Rachel Kent published outcome 10 July 2023; Chancellor responded at Mansion House 2023. - Senior Managers & Certification Regime review: Delivered - Call for Evidence launched 30 March 2023, alongside FCA/PRA joint discussion paper. - UK consolidated tape regime: Delivered - The Data Reporting Services Regulations 2024 laid on 27 November 2023 to facilitate a UK consolidated tape. - Local Government Pension Scheme asset pooling guidance: Delivered - Consultation launched 11 July 2023; closed 2 October 2023; response published 22 November 2023. - Response confirms a March 2025 deadline for transition into pools, direction towards fewer asset pools exceeding £50bn in assets under management, and sets a 10% ambition for investments in private equity. - Consolidation in Defined Contribution (DC) pension schemes: In progress - Consultation response on new Value for Money (VfM) framework published 11 July 2023. - FCA to consult on rules for contract-based schemes in 2024; TPR actions to strengthen supervisory approach from April 2023. - REIT tax rules improvement: Delivered - Legislated via the Finance (No.2) Act 2023; changes came into effect in April 2023. - Building Societies Act 1986 changes: In progress - Consultation response published December 2022. - Building Societies Act 1986 (Amendment) Act 2024 received Royal Assent on 24 May 2024 and will commence in July 2024. - Secondary Capital Raising Review outcomes: In progress - Mark Austin published outcomes in July 2022. - Government accepted recommendations addressed to it, including establishment of a Digitisation Taskforce led by Sir Douglas Flint; interim report published 10 July 2023. - PEG Monitoring Report published March 2024. - VAT treatment of fund management reform: Delivered - Consultation response published; summary of responses published 14 December 2023. ### A World Leader in Sustainable Finance - Updated Green Finance Strategy: Delivered - Published on 30 March 2023. - ESG ratings providers into regulatory perimeter consultation: Delivered - Launched 30 March 2023; closed 30 June 2023. ### Sector at the Forefront of Technology and Innovation - Retail central bank digital currency (CBDC) consultation (with BoE): Delivered - Launched 7 February 2023; closed 30 June 2023. - Consultation response published January 2024, setting out next steps. - Investment Manager Exemption expansion to include crypto assets: Delivered - Response published 9 December 2022. - Relevant HMRC regulations made 19 December 2022. - Digital Securities Sandbox (DSS): In progress - Consultation launched 11 July 2023; closed 22 August 2023. - HMT response at Autumn Statement 2023; SI laid 18 December 2023 and came into effect 8 January. - Bank of England and FCA working to set up DSS with guidance and application process forthcoming. - Private Intermittent Securities and Capital Exchange System (PISCES): In progress - Consultation published as part of Spring Budget 2024 package; closed 17 April 2024. ### Delivering for Consumers and Businesses - Consumer Credit Act (CCA) reform consultation: Delivered - Launched 9 December 2022; response published 11 July 2023. - Removing well-designed performance fees from pensions regulatory charge cap: Delivered - Consultation response and statutory guidance published 30 January 2023. - Regulations laid and came into force on 6 April 2023. - Boundary between regulated financial advice and financial guidance: Delivered (ongoing work) - Government and FCA continue review; FCA update published 3 August 2023 with updated guidance. - Joint Government and FCA policy paper published 8 December (year not specified in supplied excerpt), inviting views by 28 February 2024. ### Macroeconomic and Monetary Developments (IMF staff update) - Inflation and recent outturns: - Headline inflation fell to 2 percent in May (released on June 19), from 2.3 percent y/y in April to 2 percent in May. - Core inflation fell by 0.4 ppts and was 3.5 percent in May. - Services inflation eased from 5.9 percent in April to 5.7 percent in May (consensus and BoE expectations were 5.5 percent and 5.3 percent, respectively). - Bank of England policy: - On June 20, the MPC kept Bank Rate at 5.25 percent; voting split: seven members voted to keep rate unchanged, two voted for a 25 bps cut. - Market-implied expectations scaled up to 50 bps of rate cuts in 2024 (44 bps before the meeting); odds of an August rate cut priced at 58 percent (34 percent before the meeting). - IMF staff view: May inflation outturn narrows band around staff’s forecast of 2.1 percent 2024Q2. - Staff forecast headline inflation to rise to around 2.5 percent later in 2024 as favorable energy price base effects abate, before durably returning to the 2 percent target in the first half of 2025. - Staff baseline assumes 50 bps rate cuts in 2024; staff continues to see 50–75 bps rate cuts in 2024 as appropriately balancing risks. - Output and recent growth: - 2023 growth was 0.1%, with output falling in the second half of the year. - Q1 2024 GDP grew by 0.6% quarter-on-quarter, with strengthened output in services and manufacturing. ### Fiscal stance and public finances (authorities’ statement) - Fiscal metrics and commitments: - Primary deficit decreased from 3.6% of GDP in FY22 to 1.3% in FY24. - Gross debt-to-GDP was second lowest in the G7 in FY23. - Government states it is on track to meet both its debt and borrowing fiscal rules per Office for Budget Responsibility forecasts cited in March 2024 Budget. - Further spending decisions to be set in a Spending Review later in the year. ### Financial sector resilience and non-bank financial institutions (NBFIs) - Banking system: - UK banking system described as well capitalized and in a strong position to support households and businesses under adverse scenarios. - Financial Policy Committee maintains the countercyclical capital buffer (CCyB) at its neutral setting of 2%. - NBFI surveillance and resilience: - Authorities developing mechanisms to understand and ensure resilience of NBFIs, including support for the System-Wide Exploratory Scenario exercise and the NBFI lending tool to provide liquidity in the gilt market. - Domestic efforts complemented by bilateral and FSB work. - Market infrastructure and reforms: - Support for dematerialisation of paper share certificates via Digitisation Taskforce. - NBFI-related initiatives and taskforces progressing (Accelerated Settlement Taskforce; Digital Securities Sandbox; consolidated tape facilitation). ### Climate policy and multilateral engagement - Net zero and carbon budgets: - UK legal framework requires legally binding five-year carbon budgets; government to publish proposals and policies for meeting those budgets. - UK has delivered all three carbon budgets and over-delivered on the 2018-22 carbon budget by 15%; on track to deliver the 2023-27 carbon budget. - In 2022, UK halved its emissions compared to 1990 levels. - Since 2010, the UK has mobilized £300 billion in investment in low carbon technologies. - Authorities reaffirm commitment to net zero by 2050. - Multilateralism and IMF engagement: - UK supports multilateral institutions (IMF, World Bank, G20, WTO). - In May, UK secured legislative approval for increasing its IMF quota under the 16th General Review of Quotas. - UK provides support to the Poverty Reduction and Growth Trust and the Resilience and Sustainability Trust and supports a bigger PRGT alongside an ambitious IDA21 replenishment. - UK participates in the Global Sovereign Debt Roundtable and supports collective work on sovereign debt restructuring issues. *Source: Annex XV. The Authorities’ Update on Edinburgh Reforms (prepared for the IMF staff report and related statements, June–July 2024).* --- _Source: https://www.imf.org/-/media/files/publications/cr/2024/english/1gbrea2024001.pdf_