Weekly Economic Briefing

A late-cycle upswing

17 January 2017

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2017 seems to be shaping up to be a solid year for growth. Our current forecast is for real GDP to expand by 2.5% this year, which would be almost 1 percentage point (ppt) higher than in 2016 and also well above the average for the current expansion. Growth is set to improve in nominal terms too, thanks to rising headline inflation as the base effects of earlier falls in commodity prices continue to wash out of the numbers and more recent rises are passed through. In fact, 2017 could well be the strongest year for nominal GDP growth of the entire expansion.

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At the component level, we expect the improvement to primarily come from a pick-up in private fixed investment and faster inventory accumulation. In 2016, investment in equipment, non-residential structures and inventories all subtracted from growth, and while we do not anticipate a strong rebound by historical standards, a modest recovery is likely on the basis of recent trends in both soft and harder measures of manufacturing orders as well as construction indicators. By contrast, we have factored in a modest slowing in real consumer spending growth in line with the anticipated moderation in real disposable income as nominal wage and employment growth fail to keep pace with the aforementioned acceleration in headline inflation. The other expenditure components are unlikely to change enough from last year’s performance to significantly move the dial. Data on new housing permits and mortgage approvals for purchase are indicative of a resilient residential construction sector (see Chart 1) in the face of higher mortgage interest rates, at least so far, but growth in housing investment would need to double to significantly affect our aggregate GDP forecasts. Although export and import growth will almost certainly pick-up from their depressed rates of 2016, the two should mostly cancel each other out. Meanwhile, very little of any fiscal easing measures passed by the new Congress will occur via formal government spending.

Forecasts are unavoidable but, as any good economist will acknowledge, the future is very difficult to predict and it is at least as useful to outline the range of plausible alternatives to one’s central view. That is even truer now that there is so much uncertainty hanging over the government policy outlook. Upside risks to growth this year emanate mostly from the potential for fiscal stimulus measures to be brought forward into the first half of the year, though it also possible for business animal spirits, and thus their capital spending, to be ignited by the prospective loosening in domestic regulations. Small business sentiment has certainly reacted positively to the election result (see Chart 2). We may also be underestimating the likely pick-up in wage growth and the willingness of consumers to run down their savings against a backdrop of further wealth gains. However, important downside risks exist too. The rhetoric of an ‘America First’ growth strategy may sound appealing but if pursued in the wrong way – whether through the introduction of formal tariffs, or border tax adjustments, or higher non-tariff barriers to trade, or reduced net immigration flows – the country’s already dismal productivity performance could take another hit and invite retaliation from other countries, increasing costs for targeted firms and squeezing the purchasing power of consumers.

Jeremy Lawson, Chief Economist

 
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