IMF warns UK government as pound resumes fall

The International Monetary Fund has issued rare criticism of the UK government, warning against “large and untargeted fiscal packages”.

The statement, issued late on September 27, sent the pound down against the dollar in early trading today (September 28). Sterling was down around 0.7% at 8am UK time.

The IMF said it was “closely monitoring” recent developments in the UK, and acknowledged the government’s package was intended to help families and businesses cope with higher energy prices.

“However, given elevated inflation pressures in many countries, including the UK, we do not recommend large and untargeted fiscal packages at this juncture, as it is important that fiscal policy does not work at cross-purposes to monetary policy,” the fund said.

On September 23, the UK government unveiled a package of fiscal measures including tax cuts spread broadly across income levels and spending to curb wholesale energy prices.

The move prompted a sharp market reaction on September 26, with the pound initially falling 4.7% against the dollar before recovering. Yields have climbed rapidly – 10-year government bonds are now yielding 4.5%, up 190 basis points on a month earlier.

Jim Reid, managing director at Deutsche Bank, noted yields were rising across the curve. “For many, many years the demand for long-end gilts were seen as one of the most price-insensitive assets in the fixed income world with huge regulatory and asset/liability buying,” he said in a note. “So the fact that even this has cracked shows the deep trouble the UK market is in at the moment.”

The instability prompted the government and Bank of England to issue statements in a bid to restore calm. The government promised to allow the Office for Budget Responsibility to review its plans and said it would release more detailed fiscal proposals on November 23 alongside the OBR’s assessment.

“The November 23 budget will present an early opportunity for the UK government to consider ways to provide support that is more targeted and re-evaluate the tax measures, especially those that benefit high-income earners,” the IMF said.

The government’s plan to curb wholesale energy prices is expected to reduce inflationary pressure in the short term but raise demand in the medium term, which could keep inflation higher for longer.

The BoE will issue its next policy decision on November 3, alongside updated forecasts. Speaking on September 27, chief economist Huw Pill signalled that “looser fiscal policy” would demand larger rate increases by the central bank.

“It is hard not to draw the conclusion that all this will require a significant monetary policy response,” he said.

Pill cast the recent market moves as a “repricing”, and said his colleagues in the markets department were monitoring events closely. But he said the asset price moves would also impact monetary policy by changing the balance between aggregate supply and demand.

Some analysts had predicted the BoE would change monetary policy before November 3, but Pill said the central bank would focus on communication in the meantime. “We are relying on the basic institutional framework for macro policy in markets being effective and intact,” he said.