Rachel Reeves should refine fiscal rules to avoid emergency spending cuts, IMF says

The IMF has suggested that UK Chancellor Rachel Reeves refine her fiscal rules to avoid emergency spending cuts, proposing a shift to annual budget assessments to promote policy stability. While upgrading the UK's 2025 growth forecast to 1.2%, the IMF cautioned about trade tensions and the need for continued deficit reduction to stabilize debt and reduce vulnerability to bond market pressures. The IMF also recommends the Bank of England gradually lower interest rates, but the outlook remains uncertain due to potential shocks and global financial market volatility.

Analysis

The International Monetary Fund (IMF) has upgraded its UK growth forecast for 2025 to 1.2%, from a previous 1.1%, attributing this to stronger-than-expected 0.7% GDP growth in the first quarter of 2025. However, this upgrade only partially reverses a significant downgrade made in April from an earlier 2025 growth expectation of 1.6%. The IMF simultaneously advised Chancellor Rachel Reeves to refine the UK's fiscal rules, specifically suggesting a move from twice-yearly Office for Budget Responsibility (OBR) assessments to a single annual assessment at the autumn budget to foster greater policy stability and avoid reactive, short-term spending cuts, such as the recent £5bn reduction to the welfare budget. This suggestion could offer political leeway for Reeves, who faces internal party pressure and public calls to ease austerity, despite her stated “non-negotiable” stance on current fiscal rules. The IMF underscored the critical need for continued fiscal discipline, noting UK debt has doubled in the last 15 years and the interest bill now exceeds the capital budget, thereby emphasizing the importance of delivering planned deficit reduction to stabilize net debt and mitigate vulnerability to bond market pressures. While praising Reeves for a tough line on day-to-day spending and for directing spare funds to public investment, the IMF warned that global trade tensions, particularly US tariff plans, could reduce UK economic growth by 0.3 percentage points in 2026, though it still projects 1.4% growth for that year. The Fund also recommended the Bank of England pursue a gradual reduction in interest rates, while maintaining flexibility due to elevated uncertainty.

Key Decisions for Investors

• Investors should closely monitor UK government bond (gilt) markets and the government's adherence to fiscal deficit reduction targets, as the IMF highlights significant pressure from high national debt and interest costs.
• Re-evaluate exposure to UK assets, balancing the modestly improved near-term growth forecast for 2025 against headwinds from potential trade tensions impacting 2026, ongoing fiscal consolidation, and the prospect of gradual monetary policy easing by the Bank of England.
• Anticipate potential refinements to UK fiscal policy, particularly around the autumn budget, as the IMF's recommendation for annual budget rule assessments could provide the Chancellor with scope to adjust spending plans, impacting sectors sensitive to public expenditure and overall economic sentiment.