U.S. Growth Curbed for 2016

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The sharp revision of US second-quarter GDP growth was enough to lift our estimate for 2015 growth from 2.2 percent to 2.4 percent. However, as the boost to consumption spending from lower energy prices fades and the dollar’s appreciation trims the expansion of net exports, we have cut our estimate for 2016 growth from 2.5 percent to 2.3 percent.

Indeed, several factors suggest 2015 third-quarter growth will fall back below 2.0 percent. First-half sales grew only 1.6 percent at an annual rate while inventories increased at a much faster 5.5 percent annualised pace. That build-up of stocks reflects both slower growth of final demand, plus a surge in the growth of supply, particularly of crude oil. For the rest of 2015, stock-building will likely slip back to trend or below, cutting about one percentage point from third-quarter GDP growth.

Other developments that boosted second-quarter GDP growth are also likely to fade. Spending by state and local governments, which rebounded strongly after an unusually severe winter, will slow back to trend in the third quarter.

Also, net exports contributed to second-quarter growth, despite a falling trend, because dock strikes and the severe weather had held back earlier shipments. That strong growth is unlikely to continue either: the dollar’s appreciation is making US exports less competitive and imports more attractive. Net exports will continue to subtract about half a percentage point from GDP growth for the rest of this year and nearly as much over 2016.

However, consumption spending continues to support the economic expansion, providing an offset to the drag from declining net exports. Before the plunge in oil prices, US consumers spent about USD400 billion a year on motor fuels: if this year’s average gasoline price is USD1 per gallon cheaper, that outlay will drop by around USD100 billion, allowing consumers to spend more on other goods and services.

On a year-over-year basis, the growth in real consumer spending has picked up from 2.6 percent to 3.1 percent.

Concern that consumers are not responding to the windfall from lower fuel prices thus appears unfounded.

But the growth in real spending will likely slow once oil prices stop falling because growth in nominal incomes has not accelerated. Real incomes have outpaced inflation, which is close to zero, but nominal incomes growth is now slowing.

If crude oil prices stabilise in the coming year, inflation should average about 1.5 percent in 2016 compared to 0.1 percent this year. As it gradually picks up, real income growth will slow. That, in turn, will probably limit the expansion of real consumption spending. From an average growth rate of 3.0 percent in 2015, we expect consumer spending to slow to about 2.7 percent in 2016.

The dollar’s rapid appreciation has put downward pressure on import prices, which is having a noticeable effect on the average prices of goods purchased by consumers.

The decline in inflation has created a quandary for the Federal Reserve. While labour-market conditions are near the target of ‘maximum employment’, inflation keeps moving away from the Fed’s 2.0 percent medium-term target. With inflation falling, we believe the Fed will hold off raising short-term interest rates until December, by which time we think inflation will have stabilised and the unemployment rate will have fallen further.