12 June 2018
Coming into 2018 we were expecting a strong year for the US economy. Growth was already running at 3% annualised over the second half of 2017, and a large programme of personal and corporate tax cuts was set to come into force, providing additional short-term impetus. However, this wasn’t to be the only fiscal giveaway delivered in 2018. In early February, Congress passed the Bipartisan Budget Agreement, which paved the way for increases in defence/non-defence spending and disaster relief funding. While much of this spending will not come into force until the second half of this year, a further loosening in fiscal policy has added to concerns around overheating. Certainly, data suggest that the economy continues to grow above trend. Following a now familiar slowdown during the first quarter, activity looks to have bounced back smartly in Q2, with improving trade data the latest sign of encouragement (see Chart 2). On a more cautious note; the higher oil prices seen over recent months will provide a modest drag on consumer spending, though this will be partly offset by improving activity in the shale sector. Taken together, developments so far this year suggest growth will run a little hotter than we had factored in just six months ago.
The rise in oil prices has also forced us to reconsider short-term inflation forecasts. Price growth for energy goods and services is up 8% over 2018 thus far in annualised terms, and is set to rise further in coming months. We have also seen an uptick in underlying inflation rates, with core CPI and PCE inflation growing 2.4% and 2% in 6-month annualised terms respectively. In part this likely reflects the fading effect of temporary drags seen in 2017 (such as falling telephony service prices), past dollar depreciation and seasonal forces. Indeed, we would not interpret this acceleration as a signal that US domestically generated inflationary pressures are rapidly breaking out. Indeed, looking at the labour market, the increase in wage pressures over recent months remains modest (see Chart 3), especially when we account for some improvements in productivity. This is consistent with the view that an overheating economy will translate into gradual rises in inflation, especially when we take into account monetary policy tightening.
On policy, additional fiscal stimulus earlier in the year caused us to revise up our expectations for the Fed to deliver four hikes this year and next. One increase was delivered in March and another looks set to come later this week. We will be watching the communication closely for signs that there is appetite to maintain this quarterly pace. Otherwise, the news around trade policy this year has been worse than feared. We have already seen tariff action on solar panels, washing machines, steel and aluminium while proposed levies on $50bn of Chinese imports would come into force this month. The scale of the measures announced to date is small, muting the economic impact on forecasts so far. However, the trajectory of discussions is alarming. Given the reciprocal harm done by a large scale trade conflict, we continue to factor in only small changes to policy amid the reckless rhetoric. But it is fair to say that the risks of a deeper trade war have increased this year.