- EC downgrades forecasts, adding pressure on ECB to do more – we expect further stimulus
- US midterm election outcome not a major game changer for fiscal policy…
- …with stronger economy helping to shrink budget deficit
EC downgrades forecasts, which together with lower oil prices, add to pressure on ECB
The European Commission downgraded its projections for eurozone economic growth and inflation in its Autumn forecast update. The economy is now seen growing by 0.8% this year and 1.1% next, compared to 1.2% and 1.7% in its Spring update. While its projection for this year looks reasonable given the recent weak economic data, its growth forecast for next year seems too pessimistic to us. Fundamentals since May look to have improved given the ECB’s stimulus packages, bank re-capitalisation, a lower euro, a fall in oil prices and a strengthening US economy. Meanwhile, the EC also reduced its inflation forecasts. It now sees inflation at 0.5% this year and 0.8% next year, before rising to 1.5% in 2016. The 2014 forecast has been revised down by 0.3 percentage points, while the 2015 forecast has been revised down by 0.4. These projections are in line with our own. The EC’s revisions add to evidence suggesting that the ECB will also revise its inflation outlook lower, which could pave the way for additional stimulus. The further decline in oil prices, which is also pulling down inflation expectations in the bond market, also points in this direction. We expect the ECB to expand its asset purchases in December or January. Although we do not think it will buy government bonds, agency debt and non-financial corporate bonds are distinct possibilities.
US elections not a major game changer for fiscal policy
At the time of writing, the midterm election results are still inconclusive. But even if there is a shift in the balance of power, this will not substantially change fiscal policy in the coming two years. In FY 2014 the federal deficit was around 2.8% of GDP. This is the lowest deficit since 2007. An important factor contributing to the lower deficit is the improvement of the economy. Indeed, the fiscal stance has become more growth friendly since the recovery. US GDP is growing at the fastest pace in a decade. We expect the economy to continue to grow at an above trend rate, which will likely provide more room for revenues to increase and expenditures related to a weaker economy to decline. As a result we expect a relatively neutral fiscal stance in 2015.
Action points for the fiscal agenda
We think the US policy focus of the coming two years will remain on reforming corporate taxation, securing trade deals and increasing infrastructure and defence spending. We think that the differences between the two parties on these issues are not fundamental and that they will be able to reach common ground. Corporate taxation, for instance, has been identified as a priority by Democrats and Republicans. Both recognize that in absence of reforms, companies will increasingly move their headquarters outside the US. Defence spending has also become a relevant topic of debate given the geopolitical tensions and Republicans have been proposing to give defence spending a boots above the caps. Finally as the economy recovers there will be more pressure for spending in infrastructure
Still some uncertainty on fiscal deadlines
With respect to future discussions on deadlines, Congress will need to increase the debt limit in the second half of 2015 and political debate is unavoidable. Markets have become somewhat accustomed to the heated debates surrounding the debt ceiling in the past few years. We don’t think that a change in power would make these discussions more complicated, but they will still be tinted with uncertainty. In 2011 the heated debate surrounding the debt limit provided a hard blow for confidence in government institutions. We don’t think that they will go as far this time. Instead they will try to show that they are able to govern ahead of the presidential elections of 2016.