Steven Andrew looks across the pond and gives his view on the economic outlook for the US
The turn of the year has seen some improved newsflow. This has encouraged most commentators – and central bankers – to express greater confidence in the sustainability of the US economy’s above-trend expansion. Indeed, we have ourselves nudged up our expectation for US business investment growth this year from 6 per cent year-on-year to 8 per cent (down from 10 per cent in 2004) in reflection of the strong survey data in November and December.
But the fundamental prospects for the largest and most important sector of the US economy – the consumer – remain unchanged. We still expect the currently very high rates of consumption growth relative to incomes to normalise in the first half of this year, raising renewed questions over the sustainability of growth.
Personal consumption
Our long-standing outlook for 2005 has been that without the additional stimulus from fiscal or monetary policy changes, personal consumption growth would be entirely dependent upon income growth. With leading indicators suggesting the best has already been seen from the labour market expansion, we are forecasting no better than 150k on average over the first half of this year. Such a rate usually means that personal income grows at no faster than trend. And given that personal consumption is 70 per cent of US GDP, the growth rate here will largely determine where the US economy goes.
For now, a declining savings rate is allowing consumption to grow faster than income. But there is little further room for manoeuvre with the savings rate down at just 0.3 per cent. At the end of 2004, spending growth remained firm with US retail sales growth broadly in line with expectations. Surging car sales helped lift overall spending by 1.2 per cent month-on-month after November’s 0.1 per cent month-on-month figure – aggressive discounting by US auto manufacturers inspiring the strongest month for domestic car sales since August 2002.
Modest sales growth
Excluding cars, however, underlying sales growth was a much more modest 0.3 per cent month-on-month, down from 0.4 per cent a month ago (which was itself revised down by 0.1 per cent pt). Trade data (showing another sharp deterioration) put into stark relief the dilemma for US policymakers. In the absence of the discovery of a large, fast-growing external economy to buy American products, the choice is between sustaining US domestic demand growth at a more rapid pace than the nation’s trading partners, distending the already bloated current account deficit; or taking more rapid action to slow the economy to a pace below that of the external economy, in order to reduce the potential for the deficit provoking a more profound currency sell-off, and the consequent domestic recession. Not much of a choice.
It seems unlikely (and is certainly uncharacteristic of the central bank) that the Fed would decide on the latter route. Engineering a downturn – the consequences of which would itself be unclear for growth outside as well as inside the US – in order to address a risk which might materialise at some point in the future would be highly unusual, and probably not even desirable. For the time being, then, the Fed’s most likely course is to maintain its positive tone on economic growth, without becoming aggressive on rate policy unless it becomes apparent that inflationary pressures are re-emerging. Should personal consumption growth behave as we expect – and decelerate through the first half of this year – this is likely to mean a pause in Fed tightening in H2.
Steven Andrew is an economist at F&C Asset Management plc
Key developments
Fears over the health of the UK consumer intensified with the release of the monthly retail sales survey from the British Retail Consortium (BRC). The BRC reported Christmas sales at their worst in a decade, with December falling by 0.4 per cent year-on-year after a 0.2 per cent drop in November. In our view, the gloom is overdone in a number of respects. First, the headline BRC numbers exclude stores and retail floorspace opened up in the past year – it is not a good guide to total spending growth. The BRC's own figures put total sales growth at 2.5 per cent year-on-year in December, up slightly from 2.4 per cent in November. Second, the preponderance of gloomy reports from individual stores probably also overstates the aggregate weakness. Retailers were warned by the FSA towards the end of last year that weakness in revenues must be reported promptly to the marketplace. This will have front-loaded all of the bad news of the month's total sales performance.
UK consumers are becoming more cautious with their money and spending growth is declining accordingly, but calls for the MPC to cut rates are, in our view, well wide of the mark. With interest rates peaking at an historically low rate, inflation low and employment relatively high, decent household income growth should prevent the economy from slipping too far below trend in 2005. With the pessimism on consumer spending looking overdone, market interest rate expectations seem more likely to rise than fall in the near term.
