The International Monetary Fund on Monday upgraded its projection for U.K. economic growth in 2026 from 0.8% to 1%, while pressing the Bank of England to preserve a flexible approach to monetary policy as renewed inflationary pressures emerge.
In its assessment, the IMF said monetary policy should remain restrictive to guard against second-round effects from higher energy prices following the outbreak of the Iran war. The fund warned that rising energy costs will push up headline inflation this year and act as a drag on output.
Policy recommendation
The IMF recommended that the Bank of England hold the key Bank Rate at the current level of 3.75% for the remainder of the year to maintain a sufficiently restrictive stance. Such a posture, the fund argued, would help limit second-round effects and keep long-term inflation expectations anchored.
At the same time, the IMF emphasized that the central bank should retain the flexibility to change policy - either to tighten or to loosen - in response to exceptional uncertainty. The fund said the BOE must be prepared to act forcefully if second-round effects to inflation prove stronger than anticipated.
Near-term outlook and inflation timing
The fund noted the war in the Middle East is damping near-term prospects for the U.K. economy, which it described as having shown resilience in recent years. The IMF said it expects a gradual recovery once the shock fades.
Specifically, higher energy prices are expected to temporarily raise inflation and delay the return to the central bank's 2% target by around a year. Under the current energy price outlook, the IMF judged that keeping rates unchanged for the rest of the year should be sufficient to bring inflation back to target by the end of 2027.
Communication and decision-making
The IMF called for the BOE to ensure decisions are clearly communicated, data-dependent and decided on a meeting-by-meeting basis. The fund forecast that growth should recover in the second half of 2027 and then stabilize around potential in the medium term once the energy price shock dissipates.
For market participants, the IMF's guidance underscores two themes: the need for a restrictive stance now to anchor expectations, and the need for flexibility should inflation dynamics change. The balance between those aims will influence household purchasing power, wage dynamics and financial market pricing over the coming quarters.