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

Yahoo

3 days ago

Rachel Reeves should refine her fiscal rules to prevent the need for emergency spending cuts, the International Monetary Fund has suggested in its annual review of the UK economy, as it upgraded its forecasts for UK growth this year.
Adding to the clamour from backbench Labour MPs incensed by the government's proposed welfare cuts, the Washington-based organisation said the chancellor should examine ways to avoid having to make short-term savings when there is a downturn in economic forecasts.
Reeves came under renewed pressure on Tuesday from the Reform UK leader, Nigel Farage, who said his party would fully reinstate the winter fuel allowance that Reeves controversially scrapped for most pensioners when Labour came to power last year. Keir Starmer last week signalled a partial U-turn on winter fuel, with payments to be reinstated for some previous claimants.
On Tuesday the education secretary, Bridget Phillipson, gave the strongest hint yet that ministers intend to end the two-child benefit cap, something Farage also pledged.
Related: What are Rachel Reeves's fiscal rules and could they be changed?
An easing of the framework around the fiscal rules could give Reeves more breathing space on spending cuts. The IMF said the current system, inherited from the previous Conservative government, of twice-yearly assessments of the public finances by the Office for Budget Responsibility was ripe for an overhaul.
Instead, limiting the OBR's assessment of the fiscal rules to once a year – at the time of the autumn budget – could 'promote further policy stability', the IMF said.
It said that currently, 'there is still significant pressure for frequent fiscal policy changes, given that small revisions to the economic outlook can erode the headroom within the rules, which is the subject of intense market and media scrutiny'.
It was the need to marry up the fiscal rules, which demand that the chancellor balance the books without borrowing to cover day-to-day spending, with the OBR's forecasts in March that forced Reeves to announce savings at the spring statement, including cutting more than £5bn from the welfare budget.
Many Labour backbenchers have also called for a rethink on the fiscal rules, but Reeves and senior Treasury officials have repeatedly argued that they are 'non-negotiable'.
As well as reducing OBR forecasts to once a year, the IMF suggested introducing a process to avoid small fiscal rule breaches from requiring corrective measures outside of the autumn budget. However, it said extra tax rises or spending cuts could still be necessary 'if shocks arise', adding that failure to keep spending within the rules risked a backlash from markets.
The IMF upgraded the UK's expected growth rate this year to 1.2% from 1.1%, reversing a small portion of a large downgrade in April from October's expected growth rate for 2025 of 1.6%.
The slightly higher forecast follows the UK economy's stronger than expected start to 2025, with growth of 0.7% recorded in the January-March quarter.
However, the IMF warned that trade tensions linked to US tariff plans will reduce UK economic growth next year. It expects global trade tensions will wipe 0.3 percentage points off growth for the year, but is still predicting the economy will expand by 1.4% in 2026.
IMF officials, who have spent the past three weeks in the UK assessing the economy and public finances, praised Reeves for taking a tough line on government day-to-day spending in last October's budget and for directing spare funds to public investment.
Financial markets were on the lookout for governments that breached their spending limits, it said, adding to the pressure on UK government bonds.
'It will be important to stay the course and deliver the planned deficit reduction over the next five years to stabilise net debt and reduce vulnerability to [bond] market pressures,' it said.
Luc Eyraud, the UK mission chief for the IMF, emphasised the need to stick within spending constraints: 'Debt has doubled in the last 15 years and the interest bill is very high. Just to give an order of magnitude, the interest bill is higher than the capital budget.'
Starmer is known to be in favour of a move to annual OBR assessments, although on Tuesday his spokesperson told reporters the government sees the fiscal rules as vital and non-negotiable.
'We are talking about refinements,' said Eyraud. 'What we have been discussing with the authorities is how to support further a shift to one single fiscal event a year. And one of the recommendations is that we propose to have only one assessment of the rules each year.'
The IMF said there was a threat to its forecast for the UK from the ongoing tariff war and the prospect of a much higher US budget deficit spooking global financial markets.
It said the Bank of England should continue to lower interest rates 'gradually', while remaining flexible due to elevated levels of uncertainty.
Reeves said: 'The UK was the fastest-growing economy in the G7 for the first three months of this year and today the IMF has upgraded our growth forecast. We're getting results for working people through our plan for change – with three new trade deals protecting jobs, boosting investment and cutting prices, a pay rise for 3 million workers through the national living wage, and wages beating inflation by £1,000 over the past year.'