Truss-style tax cuts risk stoking inflation, warns IMF

The head of the International Monetary Fund has warned that energy price caps and unfunded tax cuts like those pursued in the UK are taking families on a "rough and dangerous ride" that will keep interest rates higher for longer.

In an implicit criticism of Liz Truss's growth plan, Kristalina Georgieva warned that "broad" and "indiscriminate" policies like price controls were poorly-targeted and risked stoking inflation.

In a speech ahead of next week's IMF and World Bank annual meetings in Washington, the Fund's managing director also warned that the world was edging closer to a global recession.

Ms Georgieva said shrinking real incomes and a loss in confidence would push a third of the world into technical recession before the end of 2023 - defined as two or more quarters of economic decline.

The IMF predicts this will lead to a loss in global output of about $4 trillion (£3.5 trillion) between now and 2026.

Ms Georgieva described it as a "massive setback for the world economy," adding that the Fund would further downgrade its growth projections. "It is more likely to get worse than to get better," she said. "Even when growth is positive, it will feel like a recession because of shrinking real incomes and rising prices."

Ms Georgieva's comments were delivered a week after the IMF launched a highly unusual attack on Chancellor Kwasi Kwarteng's mini-budget.

It warned that the "large and untargeted fiscal package", including abolishing the top rate of income tax, would increase inequality and make it harder for the Bank of England to keep a lid on inflation.

Government subsidies means the average household will see their energy bills capped at £2,500 for the next two years. Mr Kwarteng also reversed previous increases to National Insurance and a planned rise in corporation tax in a package totalling £43bn.

While he has subsequently reversed plans to abolish the 45p tax rate, and Ms Georgieva did not single out countries for censure in her speech, she warned that "avoiding indiscriminate fiscal support" was critical, "because if it is done on a broad basis, the boost to demand would make it even harder to fight inflation.

She added: "In other words, while monetary policy is hitting the brakes, you shouldn’t have a fiscal policy that is stepping on the accelerator. This would make for a very rough and dangerous ride."

While the UK government's action will mean inflation will peak around 5 percentage points lower than if it had not acted, economists have warned that the effective income boost for households could lead to more persistent inflation for longer.

Ms Georgieva urged governments to maintain a "laser-sharp focus on lower-income households", adding: "We know that controlling prices for an extended period of time is not affordable—nor is it effective."

Blanket measures by other countries to shield consumers and businesses have also come under fire. Germany’s €200bn (€175bn) energy bailout has sparked criticism from fellow EU countries Italy, Spain and Belgium, who claim it could distort energy markets on the Continent.

Ms Georgieva warned there could be even more economic shocks facing the global economy. "Financial stability risks are growing: rapid and disorderly repricing of assets could be amplified by pre-existing vulnerabilities, including high sovereign debt and concerns over liquidity in key segments of the financial market," she said.

"We have downgraded our growth projections already three times, to only 3.2pc for 2022 and 2.9pc for 2023. And as you will see in our updated World Economic Outlook next week, we will downgrade growth for next year."

She said inflation around the world had "remained stubbornly high and broad-based", which meant it was the "right thing" for central banks to keep raising interest rates, "even as the economy inevitably slows".

She added: "This is not easy, and it will not be without pain in the near term. But the key is to avoid much greater and longer-lasting pain for everybody."

Separate Bank of England data showed businesses fear near double-digit inflation is likely to persist for another year, despite the Government's action on energy bills. Its monthly survey of 2,500 chief financial officers showed members expect inflation to stand at 9.5pc a year from now, up from 8.4pc in the August survey.