IMF warns markets are underestimating geopolitical risks; UK faces a ‘narrow path’ on debt reduction – as it happened

Time to wrap up: here are today’s main stories.

Firstly, on the IMF’s annual meetings in Washington DC today:

The UK public finances…

And also:

The IMF has identified three risks to its forecast for 3.2% global growth in the next two years, my colleague Larry Elliott writes:

First, there’s a risk that central banks will be too slow in reducing borrowing costs, leading to slower growth and a reassessment by financial markets of their Goldilocks scenario for the global economy. Markets have bought heavily into the idea that central banks will get policy just right, engineering a return of inflation to targets without a recession. That may be true in the US, it looks less clearcut for the eurozone.

The second risk is that the war in the Middle East escalates and leads to a sharp increase in oil prices. So far, commodity markets have been relaxed about the heightened tension because they see no immediate danger of crude supplies being cut off, but that could rapidly change. Gourinchas said: “An escalation in regional conflicts, especially in the Middle East, could pose serious risks for commodity markets.” It is a warning worth heeding.

Finally, there’s the elephant in the room – the possibility that Donald Trump will return to the White House after next month’s US presidential election. While not mentioning the former president by name, the IMF estimates that a shift towards “undesirable” industrial and trade policies could reduce global GDP by 0.5 percentage points in 2026.

As far as the IMF is concerned, imposing trade barriers and subsidising domestic industry provides a sugar rush but the measures often lead to retaliation and fail to improve living standards in the longer term.

European Central Bank president Christine Lagarde has thrown her backing behind fair trade, in a pushback against the threat of more protectionism in the US.

In an interview with Bloomberg, Lagarde was reminded that Donald Trump recently said that ‘tariffs’ was his favourite word.

Lagarde, though, insists that the US has thrived thanks to free trade.

She says:

Fair trade is a key boost for growth, for employment, for innovation, for productivity.

It is something that we should not throw away.

Lagarde adds that the times in history when the US has thrived were periods of trade, not periods of “I’m going to retire behind my boundaries and play at home”.

The IMF has also warned that vulnerabilities are building up in the financial system, as markets may be underestimating the risks from conflict and upcoming elections.

In its latest Global Financial Stability Report, the Fund flags that there is a “widening disconnect” between “elevated economic uncertainty — stemming from ongoing military conflicts and the uncertain future policies of newly elected governments” and the low volatility in the financial markets.

In a warning note, the Fund reminds investors of the brief plunge in market values less than three months ago, saying:

Market turmoil in early August, though short-lived, served as a reminder of how quickly volatility can catch up to uncertainty, force the unwinding of leveraged trades, and trigger feedback loops between asset prices and deleveraging.

The IMF has also warned that it is very concerned about rising trade protectionism, at a time when a possible Donald Trump presidency looms over the global economy.

Chief economist Pierre-Olivier Gourinchas tells reporters in Washington DC that there has been a very sharp increase in the number of trade-distorting measures implemented by countries over the last five years, from 1,000 in 2019 to 3,000 today.

The IMF has calculated the impact of rising trade tensions, leading to a permanent increase in tariffs starting in mid-2025 and affecting a sizable swath of global trade.

This, it says, would cut 0.8% off global GDP in 2025, and another 1.3% in 2026.

Gourinchas says:

There is definitely a direction of travel here that we are very concerned about, because a lot of these trade-distorting measures could reflect decisions by countries that are self-centred and could be ultimately harmful not only to the global economy… but also hurful for the countries who implement them as well.

The impact on global trade also makes the residents of a country [implementing tariffs] poorer.

[Reminder, Trump has proposed a 10% across-the-board levy on all products imported into the U.S. from overseas.]

Bank of England governor Andrew Bailey is also in the US to attend the IMF’s Annual Meeting, and warning against complacency over the risk of financial crises.

Speaking at the Bloomberg Global Regulatory Forum in New York, Bailey channels mythological Greek Cassandra – whose warnings were accurate, but ignored.

Bailey explains:

As a previous financial crisis recedes over time, it is not unusual to believe that a new era has arrived. In such conditions, Cassandra like warnings that nothing basic has changed and there is a financial breaking point that can have severe economic consequences are ignored.

He also cites economics professor Hyman Minsky, who explained that the growth phase of a cycle in credit markets or business activity will end with a sudden, major collapse of asset values (A ‘Minsky moment’).

Bailey explains that memories of financial crises recede over time and can be replaced by happier thoughts of a new era arriving.

Warning against ‘the trap of complacency’, Bailey says:

I can observe this happening with the global financial crisis fifteen years or so on. I do get people telling me that ‘you have solved that one so we can relax’. But the work I set out above on theory and history is timeless. So, let’s not fall into the trap of complacency.

To combat these risks, Bailey says, regulators need better surveillance tools – particularly to keep track of the non-bank sector, which he calls “very large, and growing” [these are companies who offer similar services to banks, but aren’t actually banks]

And he wraps up with five messages on how to ensure financial stability, starting with the importance of macro-prudential regulation (rather than just a list of potential problems].

System-wide matters and should not disappear amid laundry lists.

Second, we must heed Minsky’s warning that memories of financial crises past do recede. Message three is that we have seen a shift in financial intermediation towards non-banks – from money to finance if you like and this presents distinct challenges. Message four is that one of these challenges is the pressing need for new surveillance tools.

And message five is that there is also a need for central banks to reconsider their liquidity provision tools to non-banks while not undermining the singleness and uniqueness of money.

The IMF’s chief economist has warned that countries such as the UK are treading a “narrow path” as they try to bring debt levels down.

Pierre-Olivier Gourinchas has been asked about Rachel Reeves’s plans to change the UK’s fiscal rule, to allow more investment in the budget, and about the risks of making too dramatic a change in fiscal policies.

He tells the press pack in Washington that the IMF will evaluate the details of the budget once Rachel Reeves has given it, rather than giving judgement now.

But he then says that the “broader question” is relevant for many countries, not just UK, who are treading a “narrow path in terms of fiscal consolidation”.

Gourinchas explains that when countries have elevated debt levels, when interest rates are high, when growth is “OK but not great”, there is a risk that “things could escalate or get out of control quickly”.

He says:

So there is a need to bring debt levels down, stabilise then when they are not stabilised, and rebuild fiscal buffers.

That is true for many countries around the world.

Countries who don’t do that will later find themselves “the mercy of market pressures” that will force an uncontrolled adjustment, Gourinchas warns, adding:

At which point you have very few degrees of freedom. You don’t want to get in that position, and the effort to stabilise public debt has to be seen in that contect.

But….the other side of the narrow path is that if governments try to do too much too quickly on tax and spending they will have an adverse impact on growth.

There is a need for caution, Gourinchas argues, as many countries have essential spending, such as healthcare, investment or on the climate transition.

He says:

We need to protect the kind of spending that can be good for growth.

And he concludes by explaining that achieving this “pivot” is absolutely essential.

“We are in a world where there will be more shocks, and countries need to be prepared and need to have some room on the fiscal side to deal with that.