UK: Deloitte Monday Briefing: Heading For The Fiscal Cliff

Last Updated: 17 July 2012
Article by Deloitte Financial Services Group

Most Read Contributor in UK, August 2017

If you asked a chief executive or a central banker to identify their biggest worry for the global economy they'd probably say it was the future of the euro area.

The US, by comparison, looks something of a safe haven. It has avoided Europe's double dip recession. This week's the Economist front cover headline dubs the US economy the "Comeback Kid". Forecasters expect the US to expand at four times the rate of the euro area next year.

One explanation for the resilience of America's economy is that the pace of reduction in the government's budget deficit has been slower in the US than in Europe. As a share of GDP the International Monetary Fund estimates that the US will run a larger deficit next year than Ireland, Greece, Spain or Italy's.

Yet America faces an abrupt and dramatic fiscal squeeze in less than six months. The Chairman of the US Federal Reserve has called the impending tightening a "fiscal cliff".

On 2nd January 2013 a set of tax temporary tax cuts implemented under the Bush Presidency ten years ago is due to lapse. So, too, will a payroll tax holiday implemented by President Obama in 2010. At the same time a so-called sequester, an automatic set of public spending cuts agreed in 2011, is due to kick in unless Congress reaches agreement on how to reduce the federal budget by $1.2tn by 2021.

If enacted, these three measures could take $800 billion out of the US economy in 2013. That represents a large chunk, around 5%, of US demand. There's much debate about the scale of the economic effects. But taken together these measures could easily plunge the US into recession in 2013. Even the fiscally hawkish Committee for a Responsible Federal Budget says that cutting the deficit in this manner would be "extremely disruptive and unwise".

So can the US avoid the fiscal cliff?

It seems unlikely that the Democrats and Republicans will be able to negotiate a solution in the charged and partisan period before the presidential election on 6th November. That means that a deal would need to be found during the "lame duck" session of Congress between the election and the inauguration of the President in late January. On such a contentious issue getting agreement may prove difficult.

The US could drop off the fiscal cliff early next year - but with the resulting shock to the economy subsequently triggers a new political compromise which enables some or all of the measures to be renewed.

The uncertainties surrounding the fiscal cliff are already having an impact. Writing in last Friday's Financial Times the CEO of Honeywell said that "the lack of political will to address our debt problem creates significant uncertainty for companies making investment and hiring decisions". JP Morgan has recently downgraded its US growth forecasts laying part of the blame on uncertainties caused by the fiscal cliff.

The fiscal cliff poses a serious risk to the US economy. This is likely to be a growing focus for markets as we move towards the end of the year.


The FTSE ended the week flat, with mining and media companies performing strongly.

Here are some recent news stories that caught our eye as reflecting key economic themes:


  • The Spanish government unveiled a package of tax increases and spending cuts, worth € 65bn to 2014, as part of a deal to secure European aid - Spain
  • European Union leaders approved a one-year extension, until 2014, of Spain's deadline for achieving a budget deficit of 3% - Spain
  • The Head of the IMF, Christine Lagarde, said that in the case of Greek reforms and austerity, "implementation must happen, more than lip-service" - euro crisis politics
  • The Greek unemployment rate reached a record 22.5% in April - Greece
  • China's GDP slowed to 7.6% in Q2 2012, its lowest rate for 3 years - slowdown
  • German carmaker BMW announced it is to make a further £250m of investment in its three UK Mini factories up to 2015 - car market
  • France sold € 7.7bn of treasury bills with maturities up to June 2013 at a weighted average yield of -0.006%, the first time on record it has sold debt at a negative yield - flight to safety
  • Moody's cut Italy's credit rating by two notches, from A3 to Baa2, claiming weak growth could hinder the country's ability to meet debt reduction targets - euro debt crisis
  • German consumer price inflation slowed to an annual rate of 1.7% in June, its lowest level since December 2010 - Germany
  • The International Energy Agency (IEA) forecast developing nations' demand for oil will outstrip that of industrialised countries for the first time in 2013 - emerging markets
  • Corporate bond issuance by Chinese firms hit a record $134bn in the first half of 2012, up 94.9% annually, according to Chinese data provider Wind - Chinese corporates
  • The Chinese government has, for the first time, invited applications for hedge-funds to register in the country - liberalisation
  • The US trade deficit narrowed 3.8% to $49bn in May from April, driven by a rise in exports to China and Europe - US
  • The US Federal Reserve completed an auction 10-year Treasuries at a record low yield of 1.459% - flight to safety
  • Ireland's growth for 2011 was revised upwards to 1.4%, from previous estimates of 0.7% growth - Ireland
  • The UK's Office for Budget Responsibility said further cuts to government spending or higher tax revenues would be needed to meet longer term budget targets, "primarily as a result of an ageing population" - ageing population
  • Sales at discount retailer Primark rose 16% in the 40 weeks to June 23rd, driven by a mixture of new stores and underlying growth - Primark
  • Japanese advertising company Dentsu Inc agreed to buy British advertising firm Aegis Group Plc for £3.16bn - M&A
  • The price of soybeans, widely used for feed, foods and fuels, reached a record of $16.65 a bushel on the Chicago Board of Trade, caused by drought in parts of the US - commodity prices
  • Christine Lagarde, said rising protectionism in global markets is "alarming" - protectionism
  • Analysis of more than 450,000 leaked Yahoo passwords showed "Superman" was twice as popular as "Batman" and three times as popular as "Spiderman" - safety in superheroes

In a bid to downgrade government luxury, France's new Socialist president, Francois Hollande, has reduced the ranks of his official drivers from three to two and will now stop at red traffic lights - austerity etiquette

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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