Slowing Growth Delays US Rate Increases

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A decline in US net exports is exerting a significant drag on the economy’s growth. The dollar’s appreciation, along with a slowdown in many major economies, is causing US export growth to weaken and a surge in imports that is likely to continue for the rest of 2015.

The stronger dollar is putting downward pressure on core US inflation by lowering prices of imports. For goods, the economy is experiencing deflation and even for services, inflation is falling.

We have thus lowered our forecast for US GDP growth this year to 2.2 per cent, mainly as a result of the steeper decline in net exports. In January, we had projected a 2.8 per cent increase in GDP for 2015.

With inflation remaining low and expected GDP growth decelerating, we no longer think conditions will be right for a Federal Reserve interest rate hike in September 2015. We now believe the first increase will be delayed until December and think continued slow GDP growth will limit the number of rate hikes next year.

By the end of 2016 we expect a target range for the federal funds rate of 0.75 per cent to 1 per cent rather than 1.25 per cent to 1.50 per cent we previously forecast.

For 2015, we expect net exports will drop about USD100 billion in real terms, subtracting about 0.6 percentage points from the growth of GDP. The downward revision in our forecast also comes from a more pronounced slowdown in capital expenditure in the oil sector.

While we had expected some cutbacks in capital outlays in the industry, the speed with which oil drilling has been reduced was faster than we had anticipated, and with crude prices still about 40 per cent lower than a year ago, further reductions in oil industry investment are likely, pulling down the overall level of business spending.

The increase in the GDP output gap in the first quarter of 2015 was not as large as in the same quarter of 2014, but we are less confident that GDP growth this year will rebound as smartly as it did last year. A wide output gap could restrain inflation and is one reason we think the Federal Reserve is likely to delay the start of policy tightening from September to December.

Allowing another quarter of GDP growth without starting policy restraint would help close the output gap and could be considered prudent.

Fed officials have indicated that, before beginning the process of policy normalisation, they would like to see further improvement in the labour market while being reasonably confident that inflation will return to their 2 per cent target over the medium term. We expect the unemployment rate to fall from 5.7 per cent to 5.2 per cent during 2015 but we do not think that inflation will rise much this year.