The U.S. Commerce Department has already painted a bleak picture of GDP growth, but the recovery will face tougher headwinds if fiscal consolidation efforts set in, analysts have said.
U.S. Department of Commerce said on Thursday the economy grew at a rate of 1.8 percent in the first quarter, confirming fears that the headwinds still persisted.
Economists had expected the economy to expand at a higher pace. The economy had expanded 3.1 percent in the fourth quarter.
Analysts at Capital Economics said the shift towards fiscal consolidation is another reason to suspect that the US economic recovery will remain muted.
We expect GDP growth to slow from 2.5% this year to 2.0% in 2012. In an environment where fiscal policy is being tightened, perhaps quite aggressively, we doubt the Fed will be in any hurry to tighten monetary policy and we continue to expect official interest rates to remain near zero until at least 2013, Capital Economics analysts wrote in a note.
According to the analysts, the lackluster recovery in the past few months heavily hinged on an unprecedented mix of monetary and fiscal stimulus. But there are clear signs that there is gong to be a new phase of fiscal consolidation.
The Fed may be able to offset the impact of some of the fiscal tightening by leaving interest rates at near-zero, but political opposition will limit its ability to loosen monetary policy further through additional large-scale asset purchases.
They note that state and local governments have been reducing spending for some time now owing to balanced budget rules. This contraction will be compounded by a very severe decline in Federal spending and/or rise in Federal taxes. The contraction in the public sector will far outweigh any pick up in growth in the private sector, they say.
Accordingly, the analysts have said GDP growth will slow from 2.5 percent this year to only 2 percent or so in 2012.