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US: Economy to grow significantly above potential – Nomura

Analysts at Nomura expect the US economy to continue to grow significantly above potential in 2018 and 2019, boosted by tax cuts and a pick-up in government spending.

Key Quotes

“Job gains remain well above the long-term sustainable pace and will likely push down the unemployment rate to levels not seen since the late 1960s. However, we expect soft productivity growth to persist, held down by structural declines in underlying business dynamism (e.g., the rate of new business formation and workers changing jobs). Lower dynamism also places downward pressure on wage growth.”

Inflation: Transitory factors that contributed to weak inflation in 2017 have largely reverted. In 2018 and 2019, we expect core inflation to pick up gradually as labor markets tighten and the economy operates above potential. Core PCE inflation may pick up slightly faster than core CPI as healthcare service inflation could accelerate while rent inflation gradually slows. With upside risk to healthcare prices as well as expected further labor market tightening, we expect core PCE inflation to reach 2.2% in Q4 2019.”

Policy: Facing strong momentum in aggregate demand, tightening labor markets, and inflation nearing the 2% symmetric target, we expect the Fed to hike four times in 2018 and two more times in 2019. We think the roll-off of the balance sheet will continue to exert upward pressure on long-term interest rates, as will the large increase in the federal budget deficit.”

Risks: Financial conditions remain accommodative but recent market activity, and history, suggest they can turn quickly. In our view, US-China trade pose a material risk. We think the likelihood of a NAFTA break up now sits at 25%, lower than the 40% at the beginning of 2018, but the outlook for NAFTA remains clouded.”

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