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Trump’s tax plan should boost growth, says Yellen in swansong

Tim Wallace
Janet Yellen gives her final press conference as Fed chair - AFP

Donald Trump’s tax plan should give a lift to US economic growth, investment and potentially even productivity, Janet Yellen believes.

The outgoing Fed chair said there is “considerable uncertainty” around the impact of the tax plans going through Congress, but that policymakers anticipate “some modest lift to GDP” as a result.

This comes from a base of “solid” economic growth which has left the US “in the vicinity of full employment”, she said.

Ms Yellen is leaving the Fed in February, to be replaced by Jerome Powell, and December’s rate announcement includes her final press conference.

The Federal Open Markets Committee voted to raise interest rates to 1.5pc in their third rate hike of the year.

Policymakers anticipate another three hikes in 2018, two in 2019 and two in 2020, taking the Federal Funds Rate to just above 3pc.

That is more rapid than markets anticipate, setting investors up for some potential volatility next year.

One factor behind the forecasts of steady rate rises is faster growth, lower unemployment and hints of inflationary pressures building.

The Fed upgraded its GDP growth forecast for 2018 from 2.1pc to 2.5pc and cut its unemployment prediction from 4.1pc to 3.9pc.

“We tend to see [the tax changes] as boosting consumption and capital spending to some extent,” Ms Yellen said.

“To the extent that the changes do have any positive impact on the growth of potential GDP and long-run growth this is something that, should it occur, would be welcome, as long as it is consistent with the attainment of our employment and inflation objectives.”

She said that pay growth has been weak in recent years in part because of poor productivity growth – something which extra investment might be able to change.

“In the context of an economy that has had disturbingly low productivity growth, that would be welcome and could support faster GDP growth for some period without creating a need to tighten monetary policy to offset that,” she said.

Analysts said that this mix of effects on the supply capacity of the economy versus any demand boost from the tax changes will be critical to the future path of interest rates, and that the Fed’s expectations of more rate rises could take the markets by surprise despite Ms Yellen’s efforts to make the changes clear.

“Given officials have also broadened out the arguments for higher interest rates we remain of the view that the market is being too conservative in pricing in only around two rate rises in 2018,” said James Knightly, chief international economist at ING.

“We think it will be a minimum of three with the growing prospect of a fourth should the economy respond positively to tax cuts and potential infrastructure spending plans.”

A faster pace of rate rises could have serious implications for bond prices in particular.

“If 2018 plays out like 2017, with three rate hikes from the Fed, this could spell bad news for bond prices. We have already seen bond yields rise on the assumption that rates would be hiked today and if rates and yields continue to push higher, we would expect a line to be drawn under the 30-year bond bull market,” said Tom Stevenson at Fidelity International.

“However, rising rates could be a good thing for certain sectors of the equity market such as domestically-focused companies in the US cyclical sectors of the economy, such as financial stocks, stand to do well as they profit from wider lending spreads when interest rates rise.”