Capital Economics sees US economy on track for Fed to begin tapering this year

Despite downward revisions to second quarter US GDP growth, economic analysis company Capital Economics thinks the Federal Reserve is still on track to begin tapering off its monthly asset purchases in September this year.

While GDP growth is thought to have slowed to between one per cent and 1.5 per cent in the second quarter of 2013 (lower if you work for Goldman), Capital Economics analysts anticipate a pick up in the second half of this year and in 2014 as the “drag from tighter fiscal policy begins to ease”.

The analysts have examined a number of other key indicators (all graphs from Capital Economics).

Labour market: Robust improvements points to a further pick up of nearly 200,000 in employment in July, combined with increases in average hourly earnings. The downward trend in unemployment has stalled.

Consumption: Underlying retail sales growth is slowing, but income, wealth and consumer confidence are seeing solid gains.

Inflation: Core inflation will not fall to rates low enough to prevent the Fed from tapering. Although consumer price inflation fell to a two year low last month (1.6 per cent), it is thought that the downward trend is easing.

Investment: Business investment growth has softened and inventories in particular stagnated, but a rebound is expected later this year.

External: A surge in imports in May will drag on the widening trade deficit and second quarter GDP growth, but exports expected to grow at roughly the same pace as imports over the coming months. In addition, a drop in oil imports as the US becomes less reliant and China’s surplus with the US is likely to reverse a lot of the widening.

Financial markets: The markets have adjusted to the Fed’s plans to scale down easing and to leave interest rates low. Once the Fed does start tapering its asset purchases, some of the upward support for equity prices may fade and the dollar may weaken as other central banks continue with loose monetary policies.