Country Report
POLICY TRENDS: The Economist Intelligence Unit forecasts that the federal budget deficit will remain substantial in fiscal year 2004/05 (October-September) and 2005/06, and US interest rates will continue to rise steadily. We expect the budget deficit in 2004/05 to be slightly down from last year, at 3.2% of GDP. But in 2005/06 we expect the deficit to widen to 3.4% of GDP, as government spending remains strong and the pace of economic growth continues to slow. The latest interest rate rise on May 3rd--the Federal Reserve (central bank) has tightened monetary policy in each of its last eight monetary policy meetings--placed the Federal funds target rate at 3%. The Federal Reserve still considers monetary policy accommodative and has indicated that rates will rise further at a measured pace. We expect the Fed funds target rate to reach 4% by end-2005 and to rise to about 5% by the end of 2006, as a neutral monetary policy stance is pursued
ECONOMIC GROWTH: Real GDP growth is forecast to slow to 3.2% in 2005 and 2.8% in 2006 after reaching 4.4% in 2004. Our forecast of an economic slowdown in 2005-06 is based on the impact of monetary tightening on the financial health of the personal and corporate sectors. The ending of significant fiscal stimulus is another factor. In particular, now that the impact of tax rebates during the first Bush administration has waned, it is apparent that the financial position of consumers is fairly fragile. In general, personal debt relative to income is high, making consumers vulnerable to rising interest rates. A greater share of personal income will need to be directed towards debt service, which will increasingly squeeze consumer spending in 2005-06. In addition, rising interest rates are likely to slow the house price boom, and could even threaten to push house and financial asset prices downwards. The stabilisation of property prices in the US will end the surge of household equity withdrawal that has helped to fund much of consumer spending in recent years. Also, any downward pressure on asset prices would threaten to undermine personal sector balance-sheets. This is likely to lead to a rise in personal sector saving after years of decline. The desire to save more, coupled with rising debt-service costs and the ending of fiscal largesse, suggests that consumer demand will be softer in 2005 and 2006 than in 2004.
Source: EIU Country data