Britain must “stay the course” and stick to Rachel Reeves’ fiscal rules in order to avoid market pressures, the International Monetary Fund (IMF) has warned.

The IMF, which advises on policy and gives financial aid to member countries, backed the chancellor’s economic strategy amid what it called “domestic uncertainty” and global challenges in the wake of the US-Iran war.

It said the government’s medium-term approach “continues to strike a good balance” between deficit reduction and growth-friendly spending.

In its latest assessment, the IMG gave Britain’s economic growth outlook a modest upgrade, though conflict in the Middle East is dampening prospects, threatening rising living costs and borrowing rates.

“Staying the course on deficit reduction will be important given market pressures and elevated implementation risks,” it said.

It added: “Given elevated implementation risks, sticking to the planned deficit reduction and proactively developing contingency measures would help protect fiscal credibility.”

The UK’s borrowing costs hit a 28-year high last week, as City traders braced for a potential Labour leadership challenge from Andy Burnham.

The Greater Manchester mayor’s declaration that he would seek to return to parliament, paving his way for a leadership challenge, sparked speculation that a new Labour leader could increase spending and government borrowing.

In what may be seen as a thinly veiled attack on Labour colleagues trying to oust the prime minister, Ms Reeves said in response to the report: “Putting our stability at risk when signs of progress are emerging would leave families and businesses worse off.

“Instead, this government is getting on with the job of building an economy that is stronger, more resilient, and prepared for the future.”

She added: “The IMF upgrading its growth forecasts and backing our fiscal strategy is yet more proof that this government has the right economic plan.

“The choices I have made as chancellor mean our economy is in a stronger position as we deal with the costs of the war in Iran.”

The IMF now anticipates UK GDP will expand by 1 per cent in 2026, up from last month’s 0.8 per cent forecast, made after global energy shock warnings.

However, the forecast remains lower than the 1.3 per cent growth predicted in January, before the Middle East conflict escalated.

The latest update from the IMF comes after official figures showed the UK economy grew by 0.6 per cent in the first quarter of 2026, higher than economists were expecting and the strongest growth in a year.

However, the data showed signs of so-called “front loading” in March, suggesting that businesses and consumers were bringing forward activity ahead of expected shortages in supply or price increases.

Economists warned the pace of growth is set to stall throughout the year as the impact of the Iran war begins to show.

The IMF said the UK had been “resilient in recent years” but that the “war in the Middle East is dampening near-term prospects”.

It is projecting inflation to rise to just below 4 per cent at the end of 2026, before easing back in the second half of 2027 to fall to the 2 per cent target level by the end of the year.

Interest rates are expected to be held at their current level, 3.75 per cent, for the rest of the year, under the current outlook for energy prices.

This differs from some economists who are predicting an interest rate hike this year as they think the Bank of England will want to act to keep inflation under control.

“Once the energy price shock dissipates, growth should recover in the second half of 2027,” the IMF said on Monday.

But it added that the main risk to its forecasts was a “prolonged war in the Middle East, resulting in higher energy and food prices for an extended period, and sustained global market volatility, which would weigh on confidence and hurt economic activity”.