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CHICAGO, ILLINOIS--(Marketwire - Jan. 11, 2013) - A rebound in consumer spending will lead to a breakout year for the United States, according to a new report from BMO Capital Markets Economics.

"We believe a consumer comeback will drive economic growth of 2.4 per cent this year and 3.2 per cent in 2014, about half a percentage point faster than the consensus forecast. It will also boost corporate earnings and investor confidence, supporting equities," said Sal Guatieri, Senior Economist, BMO Capital Markets.

Mr. Guatieri added that the economy likely can't return to strong form unless the consumer - weighing in at 71 per cent of GDP - bounces off the ropes. While business investment and residential construction are expected to punch above their weight this year, they account for a relatively small 13 per cent of GDP.

The past five years have been the worst for U.S. consumers in at least six decades. Personal spending fell 3.4 per cent in the Great Recession, the sharpest drop in the past eleven downturns. Furthermore, it rose just 2.1 per cent (on average) since the recession ended, the weakest pace of the past eleven recoveries.

Spending will likely remain soft early this year

Although two-thirds of the personal tax increases that were scheduled to take effect January 1st were averted by the fiscal-cliff deal, higher payroll taxes and rates on upper-income households will still drain about $160 billion (1.3 per cent) from disposable income. Moreover, job growth could be restrained until Congress addresses the debt ceiling, the sequestered spending cuts, and the continuing resolution to fund the government to avoid a partial shutdown.

In addition, consumer spending will be restrained by lofty student debt and a foreclosure rate that is still three-times higher than normal. However, assuming no major fiscal setbacks, consumer spending should improve from a sub-2 per cent rate in 2012 to a moderately strong 3 per cent pace in the second half of the year. "After squeezing household finances for five years, the financial crisis is relaxing its vice-like grip on spending," said Guatieri.

Household Finances

The household debt-to-income ratio has returned to pre-credit boom trends. As a result, after collapsing 15 per cent in the financial crisis, consumer credit (excluding student loans) is rising moderately, supported by auto financing and easier lending standards. Despite the increase in borrowing, debt-service costs remain near record lows because of low interest rates, freeing up funds for other spending.

The wealth effect has gone from vicious to virtuous. Smaller debts, higher house prices and a doubling in equity values have helped households recover four-fifths of the wealth that disappeared during the recession. "We estimate that the $6 trillion increase in household wealth in the year to Q3 contributed to half of the increase in consumer spending in that period," noted Mr. Guatieri. "There is likely some pent-up demand, notably for autos where the average vehicle age is a record 10.8 years. Following a 40-year upward march, the consumers' share of GDP stopped rising after the credit crisis, but could turn higher in the face of improved household finances and continued low interest rates."

The report also notes the positive effects that will come from the budding housing recovery on consumption. "Home sales tend to drive demand for home furnishings. Moreover, rising house prices will boost consumer confidence and grease bank lending," said Mr. Guatieri.