Market News

By David Milliken

LONDON (Reuters) -The International Monetary Fund nudged up its growth forecast for Britain this year in a regular assessment of the country's economy, and it urged finance minister Rachel Reeves to stick to her plans to lower public borrowing.

Growth this year is now forecast to be 1.2%, marginally higher than the 1.1% it predicted in April, before rising to 1.4% in 2026, despite headwinds from U.S. tariffs that are pencilled in to lop 0.3% off annual output.

"These revisions reflect the strong GDP performance in the first quarter, demonstrating the resilience of the UK economy despite the complex external environment," Luc Eyraud, the IMF's mission chief to the United Kingdom, told reporters in London.

The IMF said stronger growth in 2026 - which was the same as it forecast in April - was down to the prospect of lower Bank of England interest rates, higher asset and property prices and stronger consumption, as well as greater public spending announced by Reeves in her October budget.

The Fund expects the BoE to cut interest rates by a quarter of a percentage point once a quarter until they reach a level of around 3%, down from 4.25% currently, Eyraud said. Markets are currently pricing in just half a point of cuts over the next year.

The longer-term growth rate was also revised up to 1.4% from 1.3%, reflecting the government's aim to relax rules for new construction projects, though the IMF stressed this was sluggish by historic standards.

Reeves welcomed the growth upgrade and highlighted that Britain's growth in the first quarter of this year was the fastest among the world's seven largest rich nations.

The UK economy nevertheless faces a stiffer test from the second quarter onwards due to big rises in employment taxes ordered by Reeves and in the minimum wage, which both came into effect in April, as well as U.S. tariffs.

'STAY THE COURSE'

However, the Fund warned that she had no room to deviate from her goals to balance day-to-day spending with tax revenue by 2029/30, which have been made increasingly challenging by a rise in global borrowing that have hit Britain hard.

The cost of new 30-year government borrowing hit its highest since 1998 last month after a global bond selloff triggered by concerns about U.S. President Donald Trump's tariff policies.

"We think it's very important, in this context ... that the authorities stay the course and stick to their objective of reducing the fiscal deficit gradually over the medium term as outlined at the time of the October budget," Eyraud said.

The IMF said it saw "significant risks to the successful implementation of the fiscal strategy, from the high level of global uncertainty, volatile financial market conditions, and the challenge of containing day-to-day spending."

Reeves is due to set out budgets for individual government departments for the next three years in a spending review on June 11, after the overall total was outlined in October.

She will also have to find extra money at an annual budget in the autumn after Prime Minister Keir Starmer last week indicated that the government would partially reverse her removal of energy subsidies for most pensioners.

The IMF also proposed that Britain's Office for Budget Responsibility should place less emphasis on a cash figure for the amount of headroom that Reeves has to meet her target - which is closely watched by markets - and only publish it once a year rather than twice.

"It needs to be de-emphasised," Eyraud said. "This is not a number that translates into immediate short-term fiscal space or lack of fiscal space."

Such a change could make life easier for Reeves, who has said she only wants to make big tax and spending changes once a year, in common with most large economies - and is a shift which Eyraud said the IMF wanted to support the British authorities with.

Under the current system, mid-year swings in borrowing costs or the growth outlook can leave the government struggling to hit a target which the IMF said was based on an uncertain forecast for three years' time.

In March, Britain's government announced billions of pounds of welfare cuts which appeared aimed in part at ensuring Reeves could announce the same 10 billion pounds ($13.6 billion) of headroom as she did in October.

($1 = 0.7378 pounds)

(Reporting by David Milliken; Editing by Hugh Lawson)