Analysis: Economy would dodge bullet for now under fiscal deal

U.S. Senate Minority Leader Mitch McConnell (C) departs the senate floor with an aide after a senate vote in the early morning hours at the U.S. Capitol in Washington January 1, 2013.

Credit: Reuters/Jonathan Ernst

By Jason Lange

WASHINGTON | Tue Jan 1, 2013 2:52am EST

WASHINGTON (Reuters) - A deal worked out by U.S. Senate leaders to avoid the "fiscal cliff," was far from any "grand bargain" of deficit reduction measures.

But if approved by the U.S. House of Representatives, it could help the country steer clear of recession, although enough austerity would remain in place to likely keep the economy growing at a lackluster pace.

The Senate approved a last-minute deal early Tuesday morning to scale back $600 billion in scheduled tax hikes and government spending cuts that economists widely agree would tip the economy into recession.

The deal would hike taxes permanently for household incomes over $450,000 a year, but keep existing lower rates in force for everyone else.

It would make permanent the alternative minimum tax "patch" that was set to expire, protecting middle-income Americans from being taxed as if they were rich.

Scheduled cuts in defense and non-defense spending were simply postponed for two months.

Economists said that if the emerging package were to become law, it would represent at least a temporary reprieve for the economy. "This keeps us out of recession for now," said Menzie Chinn, an economist at the University of Wisconsin-Madison.

The contours of the deal suggest that roughly one-third of the scheduled fiscal tightening could still take place, said Brett Ryan, an economist at Deutsche Bank in New York.

That is in line with what many financial firms on Wall Street and around the world have been expecting, suggesting forecasts for economic growth of around 1.9 percent for 2013 would likely hold.

At midnight Monday, low tax rates enacted under then-President George W. Bush in 2001 and 2003 expired. If the House agrees with the Senate - and there remained considerable doubt on that score - the new rates would be extended retroactively.

Otherwise, together with other planned tax hikes, the average household would pay an estimated $3,500 more in taxes, according to the Tax Policy Center, a Washington think tank. Budget experts expect the economy would take a hit as families cut back on spending.

Provisions in the Senate bill would avoid scheduled cuts to jobless benefits and to payments to doctors under a federal health insurance program.

AUSTERITY'S BITE

Like the consensus of economists from Wall Street and beyond, Deutsche Bank has been forecasting enough fiscal drag to hold back growth to roughly 1.9 percent in 2013. Ryan said the details of the deal appeared to support that forecast.

That would be much better than the 0.5 percent contraction predicted by the Congressional Budget Office if the entirety of the fiscal cliff took hold, but it would fall short of what is needed to quickly heal the labor market, which is still smarting from the 2007-09 recession.

"We continue to anticipate a significant economic slowdown at the start of the year in response to fiscal drag and a contentious fiscal debate," economists at Nomura said in a research note.

In particular, analysts say financial markets are likely to remain on tenterhooks until Congress raises the nation's $16.4 trillion debt ceiling, which the U.S. Treasury confirmed had been reached on Monday.

While the Bush tax cuts would be made permanent for many Americans under the budget deal, a two-year-long payroll tax holiday enacted to give the economy an extra boost would expire. The Tax Policy Center estimates this could push the average household tax bill up by about $700 next year.

The suspension of spending cuts sets up a smaller fiscal cliff later in the year which still could be enough to send the economy into recession, said Chinn.

He warned that ongoing worries about the possibility of recession could keep businesses from investing, which would hinder economic growth.

"You retain the uncertainty," Chinn said.

(Reporting by Jason Lange; Editing by Eric Walsh)

View the original article here

Under pressure from Abe, BOJ boosts stimulus again

A man walks past the Bank of Japan headquarters in Tokyo December 19, 2012.

Credit: Reuters/Yuriko Nakao

By Leika Kihara

TOKYO | Thu Dec 20, 2012 2:49am EST

TOKYO (Reuters) - The Bank of Japan delivered its third dose of monetary stimulus in four months on Thursday in a prelude to more aggressive action next year, as it faces intensifying pressure from the country's next leader for stronger efforts to beat deflation.

It also signaled setting a higher inflation target at its next meeting in January, when a new government will be in place ready to negotiate with the central bank.

Shinzo Abe, whose opposition Liberal Democratic Party (LDP) won Sunday's election by a landslide, has put the central bank's independence on the line by repeatedly calling for a binding 2 percent inflation target, double its current price goal.

Feeling the heat, the central bank expanded its asset-buying and lending programme by 10 trillion yen ($119 billion) to 101 trillion yen, a widely expected move that barely moved markets.

With the latest move, the BOJ has expanded asset purchases five times this year, the most frequent activity during a single year in a decade. The last time it eased so many times was in 2001, when Japan was battling a domestic banking crisis.

"The next step is inflation targeting. The BOJ will come up with something that's just enough to avoid criticism from Abe but probably not enough to avoid some sense of disappointment," said Masamichi Adachi, senior economist at JPMorgan Securities in Tokyo.

"Abe is not even prime minister yet. If you look at how the BOJ is behaving, you could argue this is a loss of independence."

The BOJ now has a 1 percent inflation target in place, and defines a range of zero to 2 percent consumer inflation as a desirable level of long-term price growth.

The central bank said it would review that guideline next month. It will probably clarify that, after 1 percent inflation is in sight, it will aim to achieve 2 percent inflation.

The yen has fallen almost 9 percent against the dollar since September, as Abe's emergence as the likely next prime minister raised expectations of more expansionary policy and spending.

The dollar briefly edged up to around 84.39 yen after the BOJ's decision, but quickly slid back down as markets saw its action as lacking any surprises.

While Abe's prescription has had the desired market effect so far, pushing down the yen and driving the benchmark Nikkei stock average above 10,000 for the first time in more than eight months, analysts say pumping cash into the economy will only give it a temporary boost unless followed by efforts to lift Japan's growth potential and contain runaway debt.

PONDERING ACTION

Some in the BOJ, particularly officials close to the conservative Governor Masaaki Shirakawa, had wanted to delay any action until January, when there is more clarity on the new government's policies and when the central bank conducts a quarterly review of its long-term growth projections.

But that was too costly with business sentiment already slumping and companies delaying capital spending plans on weak global demand, adding to evidence that any rebound from recession early next year will be minor, analysts say.

"Japan's economy is weakening further and is expected to remain weak for the time being," the central bank said, offering a gloomy assessment of the world's third-largest economy currently enduring its fourth recession since 2000.

Speaking at an LDP meeting, Abe, who is set to take over as prime minister on December 26, said that he received a phone call from Shirakawa earlier in the day informing him of the central bank's monetary policy decision.

"I take it as that the BOJ is carrying out what we sought during the election step-by-step," he said.

Shirakawa has consistently argued that setting a 2 percent inflation target would be counter-productive in a country that has not seen consumer inflation exceed 1 percent for most of the past two decades.

But Abe made a rare, direct push for a higher inflation target when Shirakawa visited the LDP's headquarters on Tuesday, saying that the central bank must pay heed to the fact that he won an election campaigning for bolder monetary stimulus.

Abe also said that once he forms a cabinet next week he will instruct his ministers to begin working with the BOJ on setting a shared inflation target.

The LDP and its coalition partner, the New Komeito, together won a two-thirds majority in the powerful lower house that would allow them to overrule parliament's upper house in most matters, including on any bill to revise the law guaranteeing the central bank's independence from government interference.

Abe, who plans to compile a big stimulus package to revive the economy, may use that threat to nudge the central bank into buying bonds more aggressively to finance the costs.

Shirakawa, whose five-year term ends in April next year, also faced calls for bolder action from within the BOJ board.

Board member Koji Ishida, a former commercial banker, proposed - albeit unsuccessfully - scrapping a 0.1 percent interest paid to excess reserves financial institutions park with the BOJ, something Shirakawa has resisted doing so for fear of distorting proper market functions.

($1 = 84.2600 Japanese yen)

(Additional reporting by Stanley White, Tetsushi Kajimoto and Kaori Kaneko; Editing by Alex Richardson and John Mair)

View the original article here