Highlights:
- US Q2 GDP growth rose an expected 4.1% following the 2.2% growth in Q1.
- The strengthening in GDP largely reflected consumer spending growth rising to 4.0% from the 0.5% increase recorded in Q1 with additional support coming from a bounce in export growth to 9.3% from 3.6%.
- The annual increase in the core PCE deflator rose to 1.9% in Q2 from 1.7% in Q1 and thus inched even closer to the Fed’s 2% inflation objective.
Our Take:
The U.S. economy, as expected, rebounded strongly in the second quarter rising 4.1% which was almost double the 2.2% increase recorded in Q1. Thus growth over the first half of this year remained well above the economy’s long-run potential rate of 1.8%. The strengthening in Q2 was relatively broadly based with solid increase in key expenditure areas such as consumer spending (4.0%) and business investment (7.3%). On a quarterly basis there was no indication of trade protectionism weighing on activity with exports up a strong 9.3% though the monthly detail is indicative of some slowing through the quarter. This solid overall pace of growth is a reflection of still accommodative monetary conditions being overlaid by the recent highly stimulative fiscal measures by the Trump Administration in the form of both tax cuts and expenditure increases.
With the economy operating at capacity, the above-potential growth presents the risk of pushing the economy into excess demand with attendant unwanted inflationary pressures. This risk is expected to keep the Fed tightening policy. However, the pace is likely to remain gradual as the central bank seems prepared to test the economy’s perceived capacity limits. Thus after raising the fed funds range 25 basis points in June to 1.75% to 2.00%, we are assuming it will remain on the sidelines at next week’s FOMC meeting. Future rate increases are expected at a rate of once a quarter through the end of next year. Though rising trade protectionism did not seem to have any dampening impact on quarterly growth in Q2, comments by Fed officials have indicated they see this as a potential downside risk going forward.
