Global Daily – Upgrading our US economic forecast

by: Bill Diviney , Nick Kounis

US Macro: Fiscal splurge and investment to lift GDP growth this year and next – We are raising our US GDP growth forecast for both 2018 and 2019 following the passage of the Bipartisan Budget Act last week. The budget contained unexpectedly significant increases in both defence and non-defence spending (see below), the bulk of which is likely to be realised towards the end of this year and into next year. For 2018 we raise our forecast by 0.3pp to 3.0%, and for 2019 by 0.4pp to 2.7%, above the consensus forecasts of 2.7% and 2.3% respectively (consensus is now line with our old forecasts). Alongside the fiscal expansion, we have incorporated even stronger investment growth into our base line, which leading indicators such as the ISM have pointed towards. Should our 2018 forecast of 3.0%  be realised, this would be the strongest growth the US has seen since 2005. While our view that inflation will remain benign this year is unchanged, the stronger outlook, accelerating wage growth and rising inflation expectations led us to change our Fed call yesterday in favour of a steeper rate hike profile. We now expect the Fed to hike three times this year, and a further two times next year, taking the upper bound of the federal funds rate to 2.75% by June 2019. The risk to our forecast is tilted towards an additional hike in Q4 2018, particularly if wage growth accelerates to the highs that prevailed in 2007-8 (around 3.5%), which would suggest an overheating labour market.

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US budget deal points to higher Treasury issuance – The Bipartisan Budget Act represents a significant expansion in the deficit – we estimate the deficit will reach 3.7% of GDP this fiscal year (which runs to Q3), and 5.3% of GDP next fiscal year. The bulk of the expansion is likely to occur next year. Although spending caps will be lifted significantly already this year, spending will take time to be disbursed. The independent Congressional Budget Office estimates that spending will increase by $41bn this fiscal year vs the baseline, and by $161bn next fiscal year, and we have incorporated these estimates into our forecasts by assuming that nominal government spending grows by 4.8% this calendar year and by 8.0% next year. Overall, the fiscal expansion (including the tax cuts announced previously) amounts to 1.2% of (nominal) GDP relative to the CBO’s baseline estimate in 2018, and 1.6% in 2019, which should mean a corresponding increase in US Treasury issuance compared with previous assumptions. (Bill Diviney)

UK Macro: Signs of domestic inflationary pressures to trigger BoE hike – CPI inflation was stable at 3% YoY in January, which was a little higher than the consensus forecast of 2.9%. Indeed, the inflation surge – which was initially triggered by the decline in sterling – is proving to be stickier than originally thought. Goods price inflation outside energy (stable at 2.5%), which is most sensitive to exchange rate developments, has not yet significantly receded despite sterling having stabilised over the last year. Perhaps more importantly, services inflation – which is a more reflection of domestic price pressure – accelerated to 2.8% yoy from 2.5% yoy in December. The strength in services inflation is surprising given that inflationary pressures from the labour market remain muted. However, it may be a reflection of broader spare capacity constraints in the economy, which might have boosted corporate pricing power. This is certainly an area to watch. In any case, the inflation data bolster the case for a BoE rate hike in May. We expect a 25bp Bank rate hike in May, followed by a second one later in the year. (Nick Kounis)