By David Milliken

LONDON (Reuters) – The International Monetary Fund urged the Bank of England on Tuesday to avoid an “inaction bias” when it comes to raising interest rates as it forecast British inflation would hit a 30-year high of around 5.5% next year.

The BoE has said rates will need to rise to ensure that consumer price inflation – currently 4.2% – returns to its 2% target in the next couple of years.

But the central bank held off from a widely expected rate rise last month due to concern about the impact of the end of the government’s job furlough programme, and is expected to do so again on Thursday due to the spread of the Omicron coronavirus variant.

The IMF, in an annual report on Britain’s economy, said the BoE faced difficult trade-offs but should not delay too long.

“It would be important to avoid inaction bias, in view of costs associated with containing second-round impacts. Careful communication would be needed to lay the groundwork with markets for potentially more frequent policy moves,” it added.

A global inflation surge due to higher energy prices and supply-chain bottlenecks created by the COVID-19 pandemic has been exacerbated in Britain by Brexit barriers to trade and migration.

Asked if the BoE should have raised rates in November, IMF Managing Director Kristalina Georgieva told reporters the central bank “has been working with sound judgement” and noted there was an important meeting this week.

The IMF said Britain had recovered more strongly than expected from the pandemic but the latest Omicron variant was likely to cause a “mild slowdown” over the next three months.

Georgieva said Omicron could exacerbate inflation pressures in supply chains but a return to the severe lockdowns seen last year looked unlikely.

The IMF also said the BoE should also “take the earliest opportunity” to clarify how much it intended to reduce its 895 billion pounds ($1.18 trillion) of asset purchases to restore focus primarily on interest rates.

The BoE is due to complete its government bond purchases this week and has said it will stop reinvesting the proceeds of maturing bonds once Bank Rate rises to 0.5%.

GROWTH FORECAST UNCHANGED

The IMF believes Britain’s economy will expand by 6.8% this year and 5.0% in 2022, after shrinking by a historic 9.8% in 2020 when it felt the full force of the pandemic.

However, it said British output would be 2.0%-2.5% smaller than its pre-pandemic trend.

Brexit dealt significant damage to trade with the European Union and there would be further difficulties when Britain implements customs checks on EU imports on Jan. 1, Georgieva said.

The IMF broadly welcomed the approach to fiscal policy taken by Britain’s finance minister, Rishi Sunak, who said the report backed his decision to rein in stimulus measures at October’s budget.

But Britain should be ready to reinstate its furlough programme and extra assistance for the poorest households if there are significant new lockdowns, the IMF said.

The government should also consider extra fiscal tightening next financial year rather than leaving more for 2023-2024, and look at raising the tax burden on wealthier households to boost investment in infrastructure, skills and decarbonisation.

($1 = 0.7557 pounds)

(Reporting by David Milliken; Editing by William Schomberg and Paul Simao)

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