The pound is up to 10% overvalued and this is dampening efforts to rebalance the British economy, the International Monetary Fund has warned.
In its annual financial health check of the UK, the IMF welcomed forecasts that the economy is projected to grow by 3.2% this year, fuelling rapid job creation, and keeping inflation low.
However, it said that sterling is overvalued by between 5% to 10%. This could hit exports and leave the UK too reliant on imports. ‘Due to lacklustre export growth...staff estimates that the current account balance is 2.6% weaker than its equilibrium level,’ the IMF concluded.
The Washington-based fund also warned that house price inflation is ‘notably high in London,’ with prices now 32% higher than before the crisis, reflecting strong foreign demand for premium properties. Prices are also rising across the UK and people are taking out higher mortgages to afford them. Household debt is now at about 140% of households’ gross disposable income, ‘a historically-high level for the beginning of a house price cycle,’ the fund cautioned.
Philip Gerson, European Department Deputy Director at the IMF, said the introduction of more strenuous tests of loan affordability by banks is a step towards taking preventative measures. But he added that the fundamental factor driving housing price growth is inadequate supply of housing, and ‘political consensus to fix this is essential.’
In a more upbeat message, the IMF said that business investment had picked up, and this is expected to continue over the next year. On the production side, the manufacturing and service sectors have performed strongly.
Yet UK productivity still shows no sign of recovery from the recession. This is due to previous problems in credit markets, which inhibited the flow of investment to more productive sectors, the IMF said. An increase in labour supply, reflecting notably a shift towards later retirement, has also allowed firms to substitute toward labour relatively easily and cheaply.
The fund recommended the UK focuses on broadening the skill base and investing in public infrastructure to boost productivity and improve the competitiveness of the economy.