By David Milliken

LONDON The International Monetary Fund no longer expects Britain's economy to fall into a recession this year, it said on Monday as it upgraded forecasts published last month and warned that the outlook remains subdued.

The IMF said British gross domestic product now looks set to grow by 0.4% in 2023. In April, it forecast a contraction of 0.3%, the weakest outlook of any major economy.

The Fund said the improved outlook reflected the unexpected resilience of demand, helped in part by faster than usual pay growth, higher government spending and improved business confidence.

The fall in soaring energy costs and the normalisation of global supply chains also helped.

"The outlook for growth, while improving somewhat in recent months, remains subdued," the IMF said.

"Economic activity has slowed significantly from last year and inflation remains stubbornly high following the severe terms-of-trade shock due to Russia's war in Ukraine and, to some extent, labour supply scarring from the pandemic," it added.

British inflation was likely to fall to around 5% by the end of this year from more than 10% in March, and should return to its 2% target by the middle of 2025 - broadly in line with forecasts from the Bank of England earlier this month.

The economy was likely to grow by 1% in 2024 and 2% in the following two years, before returning to a long-run growth rate of around 1.5%, the IMF forecast.

Britain's growth potential could be improved by measures to tackle the impact of long-term illness on the labour force and reducing policy and regulatory uncertainty which harmed business investment, the IMF added.

A recently revised agreement with the European Union on post-Brexit trade involving Northern Ireland and a "more measured" approach to scrapping EU law should encourage business investment, it said.

The IMF said further persistence in inflation and accompanying unsustainable increases in wages were the biggest near-term threats to Britain's economic outlook and that the BoE should ensure monetary policy remained tight.

"This said, elevated uncertainty about the macroeconomic outlook and inflation persistence merits continuous review of the pace and magnitude of monetary tightening," the IMF added.

The BoE has raised borrowing costs at 12 consecutive meetings, taking rates to 4.5% this month, and financial markets see them peaking at 5% later this year.

(Reporting by David Milliken; Editing by William Schomberg and Conor Humphries)