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The US budget and inflation, credit in China and Brazil’s monetary policy

Macro Highlights - 2/19/2018

In short
  • In the United States, consumer prices rose more sharply than expected in January, but their year-on-year increase remained stable, underpinning our scenario of a moderate rise in inflation
  • The impact on GDP growth of the budget act approved by Congress, which could increase federal spending by USD300bn over two years, should be limited in 2018, due to the delay in its adoption
  • Credit figures in China suggest reduced recourse to credit through shadow banking, in line with Beijing’s will to control the country’s financial risk
  • The Brazilian central bank cut its key rates to a historical low. We believe this accommodative stance is nearing its end, given the strengthening growth momentum

United states – an above-consensus increase in consumer prices, disappointing retail sales and a reinforcement of the expansionary budgetary policy

In the US, the January consumer price index rose more sharply than expected by the consensus. There was a marked m-o-m acceleration in the CPI in January, with the overall index up 0.5% and core prices up 0.3%. The sub-components driving this rebound were, notably, apparel prices, up 1.7% over one month, and household furnishings, which rose 0.4%, both boosted by higher sales volumes in the past quarters. However, on a y-o-y basis, CPI growth stabilised at 2.1%, and 1.8%, excluding food and energy (see left-hand chart).

Moreover, retail sales were particularly disappointing in January, which tends to confirm the lacklustre nature of consumption already observed in 2017. Retail sales at current prices were down 0.3% over one month while their y-o-y increase slowed from 5.2% to 3.7% in January (see right-hand chart). The y-o-y increase in core retail sales (i.e. excluding automobiles, service stations, building materials and food) slowed to 3.9% in January vs. 5.7% in November 2017. These figures were in line with our anticipation of stable growth in consumption in 2018. Although income tax cuts could boost consumer spending slightly, the expected weakness in real wages, the slowdown in employment growth and a low savings rate could weigh on consumption growth this year. This recurring weak consumption trend backs our scenario of contained inflation growth in 2018 that would lead the Fed to make three 25bp hikes in the Fed fund rate in 2018, bringing it to 2.25%.

In terms of budgetary policy, Congress and the government made progress with regard to the 2018 and 2019 budgets. On 9 February, Congress voted in favour of the “Bipartisan Budget Act of 2018” the temporary and virtually final 2018 budget law – signed by Donald Trump the same day. The three major decisions included in this new law are the following:

  • The raising of the debt ceiling until March 2019, delaying the issue of borrowing limits until after the mid-mandate legislative elections in November 2018.
  • The raising of caps on discretionary spending[1] by a total of USD296 billion over 2018 and 2019 (USD143bn in 2018 and USD153bn in 2019), with a larger increase in the defence budget, of USD165bn, vs. USD131bn for non-defence spending.
  • Congress passed a continuing resolution, i.e. short-term legislation maintaining the current funding of the various federal agencies until final adoption of the 2018 budget on 23 March 2018, at the latest. This should give Congress the time to make the new budgetary appropriations to the different departments.

As the definitive 2018 budget is set to be signed on 23 March 2018, i.e. six months after the start of the 2018 fiscal year, the Congressional Budget Office (CBO) has estimated that all the increases in budgetary appropriations will not be spent during the current fiscal year. The CBO thus estimates that the rise in spending will come close to EUR40bn in 2018 and USD160bn in 2019. Although the final impact on GDP of this budgetary stimulus could thus be limited in 2018, it could be greater in 2019

A few days after the adoption of the Bipartisan Budget Act for 2018 by Congress, Donald Trump presented his budget proposal for 2019 on 12 February. The proposal included changes not only to discretionary spending, but also to mandatory spending programmes, which in principle are automatically renewed each year. With regard to discretionary spending, the main proposals were:

  • Eliminate the defence sequester and increase the defence budget by 777 billion over 10 years. Sequestration is a mechanism of automatic budget cuts, set up by the Budget Control Act of 2011, which consists of an across-the-board spending cut affecting most agencies, by an equal proportion to the amount of spending exceeding the set budget limit.
  • Reorganise the government and reduce non-military spending by USD1,495bn over 10 years. The proposal consists of a drastic “two-penny plan” that would reduce non-military spending by 2% each year.

Concerning mandatory spending, the main proposals were:

  • Repeal Obamacare, with the aim of reducing the deficit by 675 billion over 10 years.
  • Reduce Medicare spending (medical insurance for the elderly) by 236bn over 10 years.
  • Finance a public/private infrastructure project by injecting USD200bn over 10 years (of which USD45bn in 2019) for an overall total target amount of USD1,000bn-1,500bn for the project.

Under the Trump administration’s target[2], the deficit would increase between 2018 and 2020 (from USD873bn in 2018, or 4.4% of GDP, to USD987bn in 2020, or 4.5% of GDP) before decreasing to USD363bn in 2028, or 1.1% of GDP. This deficit reduction forecast is based on an optimistic assumption by the government of real GDP growth of 3% on average over 10 years. This 2019 budget plan has not yet been voted on, and is likely to re-emerge around the end of Q3, when the members of Congress start to integrate the proposals into their 2019 budget.

Overall, the expansionary stance of the budgetary policy has been reinforced. This expansionary trend, already seen in the tax reform adopted in December 2017, has now been amplified by the 2018 budget agreement reached with Congress on 9 February, and furthered by the Trump administration’s 2019 budget proposal. This backs our scenario of a widening of the deficit in 2018 and 2019.

China – the shadow banking market is losing steam

In China, credit issued in January recorded a clear rebound compared to December 2017. This was the case for both bank loans and aggregate lending, which includes bank credit and other sources of credit, some of which related to shadow banking activities, with the former totalling CNY2,900 billion and the latter CNY3,060 billion. However, the amount of aggregate credit issued at the start of the year was lower than in January 2016 and January 2017, at around CNY3,500 billion. Growth in the overall credit market thus decelerated, from 12.0% to 11.3% over the year. Banking credit alone, on the other hand, showed higher amounts compared to January of the previous years, posting 13.2% growth in January 2018, i.e. a slight rebound compared to December 2017 (12.7%). Although seasonal effects are most probably at play – Chinese banks tend to grant more loans at the start of the year in order to capture market share – it seems that part of the shadow financing has transferred over to banking credit under the effect of control measures taken by the Chinese authorities to limit indebtedness in the country. The components of aggregate credit related to shadow banking continued to decline in January, down from CNY118 billion to CNY357 billion in December (see left-hand chart).   

Brazil – toward the end of the central bank’s cycle of rate cuts

On 7 February, Banco Central do Brasil lowered its key rate from 7.00% to 6.75%, a historical low. The 25bp cut was smaller than previous cuts, which were all at least 50bp. Even though inflation remains anchored at low levels, it is possible that the central bank is nearing the end of its accommodative monetary policy thanks to stronger growth momentum (see right-hand chart). As such, we only expect one more rate cut in the next few months.

Lisa Turk - Economist, the United States
Sophie Casanova - Economist, Central banks
François Léonet – Economist, Emerging markets

[1] Discretionary spending contrasts with entitlement programs for which funding is mandatory and automatically renewed each year, such as Social Security and Medicare.

[2] Due to the fact that Donald Trump signed the 2018 Bipartisan Budget Act a few days before presenting the 2019 budget proposal, the government published an Addendum on 12 February specifying that the 2019 budget plan takes into account the agreement reached by Congress on 9 February, that it supports the increase in caps on military spending, but that it does not include the increase in non-military spending.