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Trends and Predictions
A Brief History
Despite being buffeted by an unexpected oil shock in Q2 last year, US
economic activity maintained its healthy growth performance,with real
GDP expanding by an estimated 4.4% over the course of 2004. More of the
same is expected in 2005. Several factors came together to subdue the
present economic recovery in its early
stages compared to its predecessors. The collapse of stock prices and
investment spending at the end of 2000 required significant adjustments
in the economy - as was particularly evident in the labour market. We
saw firms trim payrolls to cut costs and boost productivity.
The economy then also encountered a series of shocks during the recovery
phase, including a renewed fall of stock prices in 2002 due to corporate
scandals as well as anticipation of the Iraq war in early 2003,
political uncertainty in the run up to the
Presidential elections, as well as a surge in oil prices last year. The
Federal Reserve responded promptly and aggressively to the slowdown in
2001 by cutting interest
rates to 40-year lows.This, along with an accompanying decline in
long-term interest rates and a massive easing of fiscal policy, helped
to support activity over the past two years.
A strong revival of corporate profits since mid-2003 signalled the end
of business-sector adjustment.Moreover, the consistently robust pace of
economic growth prompted the Fed to start to remove some of the policy
accommodation from mid-2004. This change did little to dampen consumer
spending - in part because long-term rates remained low, but also as
labour market conditions improved, albeit
gradually, over the course of last year.
A Glimpse at What's Ahead Looking forward to 2005, several factors
suggest that growth will be maintained at an above-trend rate. The
business sector's recovery still has some distance to run - the
investment-to-GDP ratio has picked up only modestly from the lows hit in
2002. Moreover, capacity utilisation rates have risen sharply in recent
months and inventory/sales ratios are still pinned to their post-war
lows.
The weak dollar will shift some of the inventory replenishment to
domestic producers, which should add significant momentum to real GDP
growth this year. The rising pressure for domestic production will
benefit employment growth, which is expected to average 200,000 a month
or more in 2005.
Activity in the residential real estate sector is likely to cool, in
response to higher mortgage interest rates, but overall consumer
spending should benefit from stronger job growth and rising wealth.
Restraint + Growth Restraint is the new watchword for Federal government
spending, but commitments in Iraq and elsewhere will allow few cuts in
the present fiscal year, which ends in September 2005. Moreover,
restraint is
measured against previous budget projections and rarely involves more
than a slowdown in the pace of spending increases.
Healthy growth of domestic demand ,especially relative to key trading
partners in the industrialised world, will maintain upward pressure on
the current account deficit, which is expected to widen modestly to
$658bn (5.6% of GDP) this year. (This figure includes some relief on the
oil import front, as we expect the rebuilding of global inventories to
push the crude oil price in WTI terms back to the mid-$30s.)
The dollar's sizeable fall since 2002 will also boost export growth.
Even though we expect the Fed to raise short-term interest rates by at
least a quarter point at every meeting this year (to 4.25% by year-end),
this series of measured pace increases does not constitute a significant
tightening of monetary policy, given that nominal
GDP growth is rising at a rapid 6.5%-7.0% rate.Higher rates should
temper further increases in the rate of inflation.
Forecast
All forecasts come with risks and opportunities. On the plus side,
steadier and faster gains in payrolls and lower energy costs could boost
real GDP growth above our forecast. But that would be likely to trigger
faster policy tightening by the Fed. On the downside, the slowdown in
housing activity could hurt house prices, which may then rebound on to
consumer spending. A lot then depends on how the rest of the
economy is faring. In the late 1980s, falling home prices on the two
coasts coexisted with a growing economy. Though the odds favour a
similar outcome, the risks bear watching.
Information for the US Economic Update is provided by Ram Bhagavatula,
The Royal Bank of Scotland's (RBS') Chief Economist for North America.
He has been named one of the top economic forecasters in a Wall Street
journal survey of more than 50 economists. RBS, founded in 1727, is one
of the world's leading financial services groups. By market
capitalisation it is the second largest bank in Europe and ranks sixth
in the world.
FOR FURTHER INFORMATION CONTACT:
Ram Bhagavatula
FM Economics
+1 212 401 3288
ram.bhagavatula@rbos.com
www.rbs.co.uk/economics
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