Investment bank alert over fears of debt crisis in US

By Tim Sharp

Investor worries over government debt are likely to cross the Atlantic to the United States, analysts at Bank of America Merrill Lynch have warned.

After seeing Ireland and Greece forced to take bail-outs to stave off a sovereign debt crisis, and with Spain and Portugal still under scrutiny, the US could be the next on the list, the bank cautioned.

David Woo, head of global rates and currencies research, said that successful Republican pressure to restore tax cuts for high earners means there will be no fiscal tightening in the United Sates

“If anything there is going to be a bloated budget next year,” he said.

He added: “I suspect with this development there is increasing risk that the sovereign crisis is going to spread across the Atlantic to the United States.”

He went on: “I think bond market concerns will focus on the fact if you are not going to see fiscal tightening until 2012.”

President Barack Obama agreed earlier this month that tax cuts enacted by President George W Bush in 2001 and 2003 and set to expire this year would be extended at all levels, including for the wealthiest Americans, in a compromise with Republicans.

But Mr Woo said the result would be a debt to GDP ratio in the US of 80% to 85% in two years’ time.

“I think that would considerably undermine the appetite for bonds,” he said.

This could push up rates on US debt to 4% by the end of next year, he said.

It could also hit investors who are generally overweight in bonds at the moment, amid concerns about economic growth.

Mr Woo dismissed the benefits of the tax cut to the US economy.

“It is possible that people are going to save a big portion of any tax cut at the moment so it is not going to provide too much of a boost in terms of final demand but borrowing costs for the government will go up.

“It is a major risk factor that the market has yet to build into its forecasts.”

The tax cut deal has, however, prompted changes to BofA Merrill Lynch’s own predictions.

Just days after publishing its forecasts for the year ahead, the bank swiftly increased its tip for 2011 economic growth by half a percentage point to 2.8%.

For the UK, the bank expects to see growth of just 2% in 2011, in the wake of Government cuts.

“Fiscal tightening is a key contributor to that slowing,” the bank said. “While our estimates suggest that tighter fiscal policy has already imparted a drag on GDP growth in recent quarters, we anticipate a more significant impact next year, as public investment falls further, tighter current spending plans are implemented, and VAT rises to 20%.”

BofA Merrill Lynch expects UK inflation to remain at around 3%.