The Hindu Business Line : US growth: Upside surprise in store?

Higher interest rates and energy costs have the potential to crimp consumer and business spending. However, there is no chance of a sharp downturn. Consumer confidence has started looking up in the latest surveys.

Talk of a slowdown of the US economy is becoming more and more rife. The latest data, though not entirely negative, are hardly suggestive of great times ahead. Housing figures have been blowing hot and cold - starts are over forecasts, but indices of housing market sentiment are declining and the industry reports more purchase cancellations and inventories of unsold properties.

The ISM index was below expectations and construction spending too was down. Leading indicators also point to a decelerating economy. On the other hand, retail sales have held up and the revised Q1 GDP figures were better.

For its part, the Federal Open Market Committee (FOMC) - which is in charge of US monetary policy - in its usual stately language thinks `that economic growth is moderating partly reflecting a gradual cooling of house prices and the lagged effects of increases in interest rates and energy prices.' Besides, `readings of core inflation have elevated in recent months.'

Despite a warning about inflation risk, the market thought the weight of the statement was more towards stable, not rising, Fed rates in the coming meetings. Bonds rallied as did stocks.

Is growth declining? And, is inflation going to rise?

To take the first question, it is true that recent signs on the economic front are not encouraging, prompting the Fed to downgrade the economy's short-term prospects. Higher interest rates - short rates are up over 4 per cent and bond yields 3 per cent — and energy costs have the potential to crimp consumer and business spending.

However, there is no chance of a sharp downturn. Consumer confidence has started looking up in the latest surveys. Corporate balance sheets are healthier than ever with ample room for new investments. Auto giants like GM are restructuring costs and downsizing aggressively.

The spurt in M&A activity and buyouts suggests many stocks are not overvalued and offer significant upside at current prices. Optimism pervades households and business.

The global economy is witnessing sustained growth. Europe and Japan are coming out of their blues and prospects look even better for China and India, which are seeing the rapid rise of a middle class population with an urge to spend.

Thus, there is little cause for worry with regard to growth in the US and the rest of the world.

Core inflation has edged up. It is likely that producers of goods and services are enjoying more pricing power now than at other times in recent years. The proximate reason for this is not the absence of competition but the increasing price insensitivity of the affluent classes with considerable discretionary income.

Again, this hardly means runaway inflation. But clearly the days of 1-2 per cent levels are over and 3-4 per cent is more on the cards.

US growth could surprise on the upside. That coupled with the modest uptick in inflation means the Fed is on course to raising rates to 6 per cent.

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