Supporting the recovery and rebalancing the economy

The UK economy is gradually emerging from the recession and has started to rebalance away from overreliance on debt-finance and government spending towards more investment and exports. The government deficit is starting to decline, household and firm balance sheets have strengthened, but the pick-up in exports has been relatively slow despite the depreciation of sterling and the recovery in export markets. Meanwhile, the labour market has proved more resilient than in previous downturns, reflecting more labour hoarding due to falling real wages and shorter working hours. To support the recovery, monetary policy should remain expansionary, as current above target inflation rates essentially reflect temporary factors. If inflation expectations drift too far from the target, however, policy rates would need to rise earlier. The government is pursuing a necessary and wide ranging programme of fiscal consolidation and structural reforms aimed at achieving stronger growth and a rebalancing of the economy over time. Plans for fiscal consolidation, principally focusing on spending cuts, are appropriately ambitious. These plans were needed to ensure fiscal sustainability and have significantly reduced fiscal risks, contributing to lower bond yield spreads and diminished uncertainty. Fiscal plans could, however, be adjusted to better promote efficiency and long-term growth. In due course, the fiscal mandate should be modified into a permanent fiscal framework to guide fiscal policy beyond 2015/16. The UK banking sector was severely affected by the financial crisis and UK authorities have already addressed some weaknesses. Further financial sector reforms, consistent with Basel III and European initiatives to reinforce regulation and supervision, are essential to secure financial stability going forward.