US economic growth will roar back in the first quarter of 2006, prompting two more rate increases from the Federal Reserve, before slowing in the second half of the year, according to a survey of US business economists released on Monday.
The panel of 53 professional forecasters surveyed by the National Association for Business Economics have raied their consensus outlook for first-quarter economic growth to a 4.5 percent annual rate, up from 3.4 percent forecast three months ago.
The NABE panel sees the economy roaring back in early 2006 following the fourth quarter’s tepid 1.1% growth," said Stuart Hoffman, NABE president and chief economist at PNC Financial Services Group. "Our forecasters expect the economy to shake off the effects of last year’s hurricanes and surging oil prices and project strong real GDP growth of 4.5% in the first quarter, which would be the fastest quarter of growth since Q3 2003. For all of 2006, the panel expects GDP growth of 3.3%. This growth is expected to be enough to prompt two more quarter-point Fed funds rate increases to 5%. In the first NABE panel forecast for 2007, GDP growth slips to 3.1%, and the Fed eases rates.
The NABE panel’s real growth forecast for 2006 is slightly more upbeat. Year-over-year growth in 2006 is projected at 3.3%, identical to the November 2005 survey. However, the quarterly pattern of growth forecasts reveals a more optimistic assessment of growth prospects early in the year. The panel’s first quarter GDP increase forecast was revised to 4.5%, from 3.4% in the November survey, likely the result of expected reversals of forces that unexpectedly held down fourth-quarter growth. Growth over the first half of 2006 is projected to average 4%, versus 3.4% in November’s survey. However, expansion slows to just over 3% in the second half, a couple of tenths slower than was projected in November. The unemployment rate is expected to average 4.8% in 2006, two tenths lower than in November’s survey. In a first look at 2007, the NABE panel expects growth to moderate slightly to 3.1%, and the unemployment rate to edge higher, averaging 4.9%. The panel expects core consumer price inflation to edge up to 2.4%.
The NABE panel sees high and rising energy costs as the biggest risk to the expansion. By a wide margin, fully 53% of the panel ranked high energy prices as the biggest risk to the expansion. Rising interest rates also had a high rank, followed closely by declining home prices. The average rank given by the panel to several named risks, on a scale of 1 to 5 with 1 being the greatest and 5 being the least risk were: : high energy prices 1.7; rising interest rates 2.4; declining home prices 2.7; falling net exports 4.5; auto industry retrenchment 4.7. Six panelists cited terrorist attacks in the U.S. as a significant risk to the expansion.
Despite these risks, the expansion is not expected to end anytime soon. The NABE panel thinks there is only a 15% chance the expansion will end in 2006 and 25% probability that 2007 will see the cyclical peak in economic activity.
The NABE panel expects payroll employment growth of 1.6% (2.1 million jobs) in 2006 and 1.3% (1.8 million jobs) in 2007. This is just strong enough to maintain the civilian unemployment rate at an average of 4.8% this year, up slightly from January’s reading of 4.7%. The unemployment rate is expected to edge up to average 4.9% in 2007 as overall economic growth slows to just 3.1%. The NABE consensus also foresees fairly steady productivity growth of close to 2.5% in both years. Growth in unit labor costs are expected to rise from 1.6% in 2006 to 1.9% in 2007. Worker compensation growth is projected to rise slightly from 4.1% in 2006 to 4.4% in 2007.
The NABE consensus revised upward its expectations for oil prices. A barrel of crude oil is expected to be trading at nearly $59 at the end of this year, up from $53 expected in November’s survey. To further assess the risk for sustained higher crude oil prices, we asked the NABE panel to assign likelihoods to various ranges for the price of a barrel of crude oil at the end of this year.
The NABE panel made another upward revision to its expectations of headline inflation for 2006. Reflecting the upward adjustment to its projection of energy prices the panel revised upward by two tenths its projection for inflation in 2006 as measured by the consumer price index (CPI). The CPI is now expected to advance by 2.5% (fourth quarter-over-fourth quarter) this year, up from 2.3% reported in the November survey. For 2007, the panel still sees all-items CPI inflation of 2.3%, held down by moderating energy prices. In contrast, the core CPI is now projected to increase 2.3% in 2006, one tenth lower than in November’s survey, and 2.4% in 2007.
The panel expects the Federal Reserve to raise the Fed Funds rate to 5.00%, the expected peak in this tightening cycle, before the end of this summer. (See the table on page 4 showing the median panel expected funds rate through the end of 2007.) Notably, upside risk to the NABE consensus forecast of the Fed Funds rate is represented by the average of the highest five Fed Funds rate forecasts reaching 5½% by the end of 2006 and 5¾% in 2007. (See page 5.) In 2007, the full panel expects the Fed to gradually lower the Fed Funds rate back to 4.50% by the end of that year, the panel’s estimate of the neutral rate (as determined in the November 2005 survey).
When asked to identify what they believed are the Fed’s long-run inflation objectives for the core CPI and core PCE price index, the panel’s mean responses were 2.0% and 1.8% for the core CPI and core PCE price index, respectively.
Long-term rates are now expected to rise somewhat more slowly than previously. The yield on 10-year Treasury notes is projected to average 5.00% in December 2006, down from 5.15% in the November survey. However, the panel expects the yield to continue to rise in 2007, reaching 5.16% in June 2006, before retreating to 5.05% by year’s end. The average of the highest five forecasts for the 10-year note yield reaches 6% by the end of 2007 with the five lowest forecasts averaging 4.23% at the end of next year.
Consumer spending growth is expected to moderate this year and next. Real personal consumption expenditures (PCE) are projected by the panel to rise 3.2% this year, up from November’s forecast of 2.9%, but down from 3.6% in 2005. In 2007, PCE growth is expected to slow further, to 2.9%. Sales of light vehicles are expected to slide to 16.6 million units in 2006 from 16.9 million in 2005, and slip further to 16.5 million in 2007. The panel expects nonresidential business fixed investment to remain quite strong in 2006 with growth at 7.9%, slipping to a still solid gain of 6.3% in 2007.
Housing starts will fall this year and next. Currently, the NABE panel forecasts starts of 1.9 million units this year and 1.8 million in 2007. Residential investment is projected to rise 0.3% in 2006 (on a year-over-year basis) and decline in 2007 by 2.4%.
Industrial production growth is expected to improve, but remain moderate. NABE panelists expect industrial production growth to rise from 3.2% last year to 3.6% this year. In line with the overall moderation in growth expected in 2007, industrial production growth is projected to slow to 3.3%. The manufacturing capacity utilization rate is expected to rise from an average of 78.5% last year to 80.1% this year and to 81.0% in 2007.
The trade balance is expected to continue to deteriorate in 2006, then improve in 2007. Last year, the trade deficit was $766.8 billion. In 2006 it is expected to come in at $792 billion, improving slightly to $785 billion in 2007. Projected 2006 real net exports are expected to be slightly more negative in 2006 than in 2005, at -$652 billion. A slight improvement to -$638 billion is expected in 2007. A weakening dollar (see below) is expected to contribute to the trade improvement.
Slightly more than half of the respondents felt that capital inflows to the U.S. would remain roughly the same in 2006 as in 2005. Roughly 35% of the respondents, however, felt capital inflows would decelerate, while only 14% felt they would accelerate. When asked about the implications for long-term interest rates of these expectations, those expecting decelerating capital inflows felt that the impact on the 10-year Treasury note yield would be about plus 26 basis points.
The NABE panel sees a falling dollar in 2006 and 2007. The panel expects the dollar to weaken against the euro this year to an average level of 1.22 $/euro, compared to 1.18 $/euro last December, and then slip another 2½% next year to 1.25 $/euro. The panel sees a similar outcome for the dollar against a broad basket of currencies, as the Fed’s trade-weighted broad dollar index is expected to slip to 97.0 this year, from 98.3 last year, and slip further to average 95.3 in 2007.
The panel projects the federal deficit to worsen from a reported $318 billion in FY 2005 to about $374 billion in FY 2006. This compares favorably with the deficit projection released from the White House on February 6th of $423 billion. The panel projects a deficit of $370 billion in FY 2007, compared to the administration’s projection of $354 billion. When asked what impact partial troop withdrawals from Iraq might have toward reducing the deficit, the consensus of the panel was $8 billion in 2006 and $23 billion in 2007.
