Uncertainty Clouds the United Kingdom’s Economic Prospects

U.K. economy performed well, with good growth and record employment

Buoyant property markets, slow productivity growth, and high current account deficit risks to growth

An exit from the EU would likely entail substantial economic, financial costs

Economic growth has consistently been near the top among major advanced economies, the employment rate has risen to a record high, the fiscal deficit has been reduced, and major financial sector reforms have been adopted, the report notes.

Nevertheless, there are risks to the outlook, including the possibility of a reversal in recently buoyant housing markets, a wide external current account deficit and low household saving rate, and continued slow productivity growth. The referendum on the U.K.’s continued membership in the European Union, to take place on June 23, is a major source of uncertainty.

Reflecting in part uncertainty about the upcoming referendum, economic growth slowed in the first half of this year. If the country decides to stay within the EU, growth is expected to rebound later this year and to remain steady over the next few years. Inflation should gradually rise to target after the effects of past oil and other commodity price falls dissipate and as low unemployment helps push up wages.

Risks remain

“Despite the positive overall outlook, extending growth into the medium term will depend on addressing lingering domestic and external risks,” according to Philip Gerson, Deputy Director of the IMF’s European Department and U.K. Mission Chief.

In common with many advanced economies, productivity growth has been low for several years. With employment at record highs (Chart 1) and the unemployment rate low, future income growth will increasingly depend more on boosting the amount of output per worker (that is, on higher productivity) than on increasing employment.

The U.K. also continues to struggle with a wide current account deficit. The large deficit to some extent reflects a low return on U.K. investments abroad, especially elsewhere in Europe. This should improve somewhat over time as economic conditions in other countries strengthen. In the meantime, the large current account deficit leaves the U.K. vulnerable to changes in economic sentiment that could make it more difficult to finance investment and hence slow growth.

Commercial and household real estate markets have been buoyant in recent years, and the share of new mortgages at high loan-to-income ratios has been rising...