IMF nudges up UK's 2025 growth forecast, sees 'significant risks' to deficit goals

The IMF has marginally increased its 2024 UK growth forecast to 1.2%, up from 1.1% in April, citing strong Q1 GDP performance and resilience in the face of a complex external environment; however, the IMF urges Chancellor Rachel Reeves to maintain her fiscal deficit reduction plans amid rising global borrowing costs, and also suggests de-emphasizing the Office for Budget Responsibility's closely watched headroom figure due to its reliance on uncertain forecasts.

Analysis

The International Monetary Fund has slightly upgraded its UK economic growth forecast for 2024 to 1.2%, a marginal increase from its April projection of 1.1%, primarily driven by a robust GDP performance in the first quarter. The IMF anticipates growth accelerating to 1.4% in 2026, supported by its expectation of the Bank of England cutting interest rates by a quarter of a percentage point quarterly from the current 4.25% to approximately 3%—a more aggressive easing path than the half-point cut over the next year currently priced by markets—alongside higher asset prices and stronger consumption. However, this outlook faces headwinds including anticipated U.S. tariffs projected to reduce annual output by 0.3%, recent increases in UK employment taxes, and a higher minimum wage. Critically, the IMF has issued a stern warning to UK finance minister Rachel Reeves, urging adherence to fiscal consolidation plans aimed at balancing day-to-day spending with tax revenue by 2029/30, especially as the cost of new 30-year UK government borrowing recently reached its highest level since 1998. The Fund highlighted "significant risks" to the fiscal strategy's implementation from global uncertainty and volatile markets, and proposed that the Office for Budget Responsibility de-emphasize its fiscal headroom figure, publishing it annually to reduce sensitivity to short-term market fluctuations and uncertain long-term forecasts.

Key Decisions for Investors

• Investors should acknowledge the modestly improved near-term UK growth outlook but remain highly attentive to the significant fiscal risks and rising sovereign borrowing costs highlighted by the IMF, which could impact UK asset valuations.
• Monitor upcoming UK fiscal announcements, including the June 11 spending review and the autumn budget, for adherence to the medium-term fiscal consolidation path, as deviations could exacerbate gilt market volatility and affect investor confidence.
• Assess the divergence between the IMF's projection of Bank of England rate cuts to around 3% and current market pricing, as convergence towards the IMF's view could present opportunities in UK rate-sensitive sectors and influence sterling exchange rates.
• Incorporate the identified headwinds, such as U.S. tariffs potentially shaving 0.3% off annual output and domestic fiscal tightening through employment tax hikes, into medium-term UK economic and corporate earnings projections.