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TD Economics: Full Steam Ahead for America's Economy

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TD Economics: Full Steam Ahead for America's Economy

Economic growth to accelerate to 3% in 2015, following 2.3% in 2014.

America's economy is gaining steam and lower oil and gasoline prices are adding fuel to the fire according to a report released today by TD Economics, an affiliate of TD Bank.

"The fall in energy prices could hardly have come at a better time, said TD Chief Economist, Craig Alexander. Just as the job market is hitting its stride and wages are moving up, energy prices are falling, reducing inflation and leaving more money in consumers' pockets."

"The biggest change on the economic landscape over the past few months has been the rapid decline in energy prices."

After averaging 2.3% in 2014, the economy is expected to grow by 3% in 2015. With faster growth, the unemployment rate will continue to fall, reaching 5.5% by the end of next year.

Lower gasoline prices a boon to American households

The biggest change on the economic landscape over the past few months has been the rapid decline in energy prices. Since September, oil and gasoline prices have fallen more than 40%.

The decline in energy prices is a simple matter of supply and demand. "The fall in the global price of oil reflects the combination of rapidly rising production in North America and falling consumption in emerging markets," said Alexander.

American consumers are the clear beneficiaries.  "While falling prices will slow growth in oil-producing regions of the country, the average American household will save over $500 on gasoline over the next year," said Alexander. "Money that is not funneled into gas tanks will be used on other goods and services, providing an important lift to consumer spending."

As a result of the decline in prices, TD Economics has lifted its expectation for consumer spending growth by 0.3 percentage points over the next year relative to its previous forecast in September.

The high-flying dollar will be a challenge to exporters

The flipside of the decline in energy prices is the rise in the dollar. It's hard to find a currency that has not fallen in value relative to the dollar over the past several months.

Like oil, the high-flying greenback reflects the divergence in economic performance between America and the rest of the world. "With weak economic growth and inflation in Europe and Japan, foreign central banks are doing more just as the Federal Reserve is doing less," said Alexander. "Alongside declines in commodity-producing currencies, this has meant broad-based increases in the dollar."

A rising U.S. dollar offers some benefits to America, by reducing the price of imports. Over time, this will show up in a lower rate of consumer price inflation. The forces behind the stronger dollar are also keeping downward pressure on long-term interest rates, further supporting consumers and home purchasers. In the near-term, however, it will be a challenge to the nation's exporters, whose goods will be more expensive to foreign buyers.

"Given the magnitude of the dollar's rise, some of the additional consumption we expect over the next year will be imported from abroad," said Alexander. "This will provide a much needed lift to growth in the rest of the world, but also means that a rising trade deficit will weigh on U.S. growth."

The Fed will raise rates next year, but with inflation falling, it can afford to be patient

With economic growth set to gain speed, the unemployment rate will continue to move down over the next year. Taken by itself, the improvement on the job front should mean higher interest rates. However, this is balanced against an inflation outlook that has become increasingly benign over the next year.

"The Federal Reserve does not set policy for the inflation rate today, but for where it expects it to be in the future," said Alexander.  "As a result, the Fed will look through the temporary weakness in inflation to indicators of future price growth."

Rising job openings, falling unemployment, and rising wages are all signs that, as the temporary impact of decreasing energy prices falls out, inflation will move toward the Fed's target.

TD Economics expects the Federal Reserve to begin its rate hiking cycle in the second half of next year and bring the Fed funds rate up to 0.75% by the end of the year. By the end of 2016, the fed funds rate will likely only be at 1.75%, which is still a highly stimulative monetary setting.

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