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Monthly Economic Outlook

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Sub−Par Growth: Economic Workout Continues

Wed, Jun 11 2008, 10:44 GMT
by Wachovia Research Team

Wachovia

U.S. Overview

Sub-Par Growth: Economic Workout Continues

Our outlook remains for sub-par growth with weakness continuing in consumer spending, residential investment and capital spending for the second half of this year. In contrast, government and net exports should continue their positive momentum. Overall, our expectation is that real final sales will grow at only one percent in the second half of this year compared to 2.5 percent for all of 2007. Inflation, as measured by the core PCE deflator, remains at the top end of the Fed’s perceived target range as import prices, energy and food add to the upward momentum in prices. This combination of sub-par growth and persistent inflation suggests that the Federal Reserve keeps the funds rate on hold through the rest of this year. Finally, sub-par growth coupled with rising input prices will drive weaker pre-tax profits for the rest of this year.

Sub-Par Growth: Consumer and Business Restraint

Consumer spending is expected to remain weak after the initial stimulus of the rebate checks. Real personal income growth has slowed this year relative to the prior two years as inflation has picked up while job growth has turned negative. Lower real income growth, combined with losses in real estate wealth and diminished consumer confidence combine to generate consumption of just 1.6 percent for 2008 compared to 2.9 percent last year.

International Overview

Long-term interest rates in most major economies have moved up sharply in the last week or two as central bankers have turned hawkish. The surge in energy and food prices has had only limited effects on core rates of inflation so far. However, central bankers appear determined to avoid a replay of the 1970s when sharp increases in energy prices led to generalized acceleration in most other consumer prices. Credit market dislocations and forecasts of slower growth had led investors to anticipate ECB easing by the end of the year. However, the ECB has refrained from cutting rates, and it now looks like it will raise rates by the end of the year to keep inflation expectations contained. Although the Bank of England will probably cut rates again before the end of the year, the recent rise in CPI inflation makes a significant amount of easing less likely. Changes in our interest rate outlook have some implications for our exchange rate forecasts. We had projected the dollar would begin to strengthen versus the euro in the third quarter of this year as investors began to anticipate Fed rate hikes. With rates heading higher in the Euro-zone and not rising as fast in the United States as we had originally projected, the dollar will likely continue to struggle versus the euro in the near term. Although the euro could easily test its all-time highs, we do not believe a sharp decline in the dollar is likely. U.S. officials have recently hinted at the possibility of foreign exchange market intervention, which would give the greenback some support if it came under selling pressure.

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Published on  Wed, Jun 11 2008, 10:53 GMT