LONDON (Reuters) - Britain should ramp up public investment if the economy slows sharply ahead of its divorce with the European Union, the OECD said on Tuesday as it stayed downbeat about the world’s No.5 economy.
In a review that focused heavily on Britain’s poor productivity performance, the Paris-based Organization for Co-operation and Development also said the Bank of England should keep monetary policy loose ahead of Brexit.
Britain’s economy held up better than most forecasters thought immediately after the shock Brexit vote in June 2016, but it has slowed in 2017 as rising inflation has pinched the spending power of households.
The OECD repeated its forecast from September that Britain’s economy looks likely expand by only 1.0 percent next year, slowing from growth of around 1.6 percent this year.
The OECD assumed a “least favorable” Brexit outcome in which Britain leaves the EU in 2019 without a trade deal or a smooth transition, reverting to World Trade Organization rules instead.
Most other forecasters assume Britain will strike a deal with the EU to avert a disruptive Brexit.
Some economists have said the risk of no deal has increased in recent weeks, citing a divided British government and the EU’s strict adherence to its negotiating guidelines.
The OECD said a transition agreement - something Britain wants to talk about now with the EU - would limit the damage from Brexit.
“(Brexit) has raised uncertainty and dented business investment, compounding the productivity challenge,” it said.
Last week Britain’s budget watchdog said it expects to cut “significantly” its productivity growth forecasts for the next five years, potentially slowing overall economic growth, hurting the government’s finances and the outlook for living standards.
The OECD said if the economy slows sharply, the government should find investments that would boost productivity and be started quickly.
It noted a fall in net migration to Britain since last year’s Brexit vote. If that trend intensified, it could reduce the labor force and productivity growth, given that migrants tend to possess higher skills, it said.
“Rapidly concluding negotiations to guarantee the rights of EU citizens is a priority to sustain labor supply and ensure further progress in living standards,” the OECD report said.
If Brexit were reversed, whether through a change in government or a new referendum, it would result in a “significant” boost to economic growth, the OECD said.
Responding to the OECD report, Britain’s finance ministry said increasing productivity was already a priority, citing its 23 billion-pound fund for infrastructure, research and development and housing.
Finance minister Philip Hammond does not have much leeway to spend more, if he wants to stick to his plan to eliminate Britain’s budget deficit by the mid-2020s. But he has come under growing pressure from within his ruling Conservative Party to do more to counter the threat from the left-wing Labour Party.
While most economists expect the Bank of England to raise interest rates in November, the OECD said it should “look through” the boost to inflation from the weak pound.
“Monetary policy should remain supportive amidst the ongoing slowdown in the economy as the negative effects of Brexit continue to materialize,” the OECD said.
The OECD described high rates of consumer lending growth, coupled with stagnant household incomes, as a “major financial stability risk” - a starker assessment than the BoE’s.
The BoE has said there is no overall debt bubble in Britain but it has expressed concern about consumer debt, which had been growing at about 10 percent a year.
The OECD recommended introducing a debt-to-income ratios for all types of borrowing - something that the BoE has so far only deemed appropriate for mortgage lending.
Editing by William Schomberg