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TD Economics: Economy Will Maintain Momentum in 2014

June 24, 2014, 06:00 AM
Filed Under: Economy

Economic growth stumbled in the first three months of this year, but bounced back in the spring and will maintain momentum over the remainder of 2014, according to a report released today by TD Economics.

"Despite the setback to the broader economy in the first quarter, job growth remained resilient and has picked up speed in recent months," says TD Chief Economist, Craig Alexander. "Rising job openings, increased small business confidence and the fastest credit growth since the recovery began are all reasons to remain optimistic about the prospects for the economy."

Economic growth is expected to average over 3% through the rest of this year, but as a result of weakness in the first quarter, the economy will grow by just 2.2% on an annual average basis in 2014. Real GDP growth is forecasted to accelerate to 3.1% in 2015.

Housing hits a speed bump...

One of the factors contributing to economic weakness in the first quarter was a setback in the housing market. The downturn in housing reflected the combination of bad weather, deteriorating affordability, and tightening lending standards. Fortunately, many of these headwinds have since faded.

The housing market recovery is still in its early stages, but the path forward will not be a straight line. Nonetheless, as job growth gains speed, pent-up demand for housing should begin to re-emerge, providing a solid impetus to housing construction.

Alexander notes that "the single-most important feature of the current real estate market is not the temporary weakness in demand, but rather the general lack of supply. Given growth in the adult population and scrappage of older homes, America should be building at least 1.4 million homes a year. In May, the annual rate of housing starts was only 1.0 million, a far cry from normal."

Looser monetary policy in Europe puts downward pressure on U.S. interest rates...

Besides the weak pace of economic growth to start the year, the other surprising development has been the decline in long-term interest rates.

"The fall in interest rates ran contrary to analysts' expectations," says Alexander. "While weak domestic economic growth was a factor, perhaps the biggest driver was the situation in Europe."

Inflation in Europe fell to just 0.5% in May, creating widespread expectations that the European Central Bank (ECB) would step in with additional monetary stimulus. These expectations were met in June when the ECB brought interest rates to unprecedentedly low levels.  These low rates channeled investors into higher yielding U.S. bonds.

"The other side effect of the ECBs additional policy support is depreciation in the value of the Euro relative to the U.S. dollar," says Alexander. "Going forward, this will make imports cheaper relative to exports and, as a result, net-exports are likely to exert a modest drag on economic growth. On the plus side, it should also keep a lid on U.S. inflation."

In America, unemployment is falling and inflation is rising...

The fall in interest rates experienced over the first half of this year is unlikely to be repeated in the second half. Instead, the combination of a strengthening job recovery and modestly higher inflation should lead to gradually rising rates.

"Signals from the job market have been one of the most encouraging aspects of the U.S. economy over the last several months. Not only has job growth gained speed, but job openings have risen to their highest level in over six and a half years" says Alexander. "This suggests that monthly job gains will likely continue to sit north of 200K and we should see even larger gains as the year rolls forward.

As the unemployment rate falls, pressure on inflation is likely to rise.

"Inflation may be falling in Europe, but it is picking up in America" says Alexander. "While the strengthening dollar is a moderating force on inflation, a tightening labor market will eventually create some pressure on price growth."

Eventually, the move closer to target on both the inflation and unemployment fronts will nudge the Federal Reserve off the sidelines. TD Economics expects the first hike in interest rates to occur in the final quarter of 2015, marking the beginning of the Fed's rate hike cycle.

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