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After the fiscal cliff, U.S. lawmakers heading for another showdown

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JONATHAN ERNST/REUTERS U.S. President Barack Obama delivers remarks next to Vice President Joe Biden (L) after the House of Representatives acted on legislation intended to avoid the “fiscal cliff,” at the White House in Washington January 1, 2013. REUTERS/Jonathan Ernst

The last-minute fiscal cliff deal will cut the United States’ economic growth rate by 1.5 percentage points this year, economists estimate.

That’s roughly in line with most economists’ forecast.

But while the deal softens the worst of the tax hikes and spending cuts that were scheduled to take effect Jan. 1, other obstacles lie ahead.

In particular, the coming negotiation over the U.S. debt ceiling, as well as the spending cuts put off by the eleventh-hour agreement, means that Republicans and Democrats will clash bitterly – againabout two months from now.

“There’s euphoria because we’ve avoided a recession, which would be pretty damaging to Canada as well. But what we’ve done is swap one crisis for another,” said Paul Ashworth, chief U.S. economist for Capital Economics in Toronto.

“Out of the frying pan, into the fire.”

The hastily-passed American Taxpayer Relief Act of 2012 steered the U.S. around a recession by shrinking a slate of automatic tax increases and spending cuts that would have carved $ 600 billion out of the economy.

The bill contains modest tax hikes for most Americans and larger ones for higher income earners. But it also postpones until next month the question of what to do with about $ 110 billion (U.S.) in automatic spending cuts.

The problem is that mid- to late-February is also when the U.S. will bump up against its $ 16.4 trillion (U.S.) debt ceiling. That’s the maximum amount that the U.S. is allowed to borrow, as set by lawmakers.

Investors breathed a sigh of relief on Wednesday, but economists and other financial experts remain on guard.

Federal Finance Minister Jim Flaherty said that while he is pleased to see the agreement south of the border, the U.S. isn’t out of the woods yet.

“Canada welcomes the agreement reached between the president and the Congress that protects the U.S. economy in the short term,” he said in a statement Wednesday.

“That said, there remain a number of significant risks to the U.S. economic outlook. It is my hope that leaders in the United States continue to work together to develop future action that will put the U.S. fiscal position on a sustainable path.”

Economists say the latest agreement comes just as U.S. was finally showing solid signs of recovery, five years after the Great Recession.

In particular, the housing market and the labour market, both crucial to consumer spending, are getting stronger.

“If it weren’t for the cuts, we think the U.S. economy would be looking at a very strong year for growth,” said Doug Porter, deputy chief economist at BMO Capital Markets.

“We think it would have had growth of about 4 per cent.”

Most economists expect the Canadian economy to grow by a little under 2 per cent this year – tepid growth that has more to do with slowing global demand for commodities than the averted fiscal cliff.

High household debt levels and federal government tightening will also keep a lid on Canadian growth this year.

Forecasts for Canada’s GDP are little changed by the deal. Economists had expected some compromise by U.S. lawmakers on tax hikes and spending increases.

They also expected the approaching debt ceiling would have been part of the fiscal cliff negotiations, but that didn’t happen.

Now, Republicans, who are angry that the deal hiked taxes and did little to curb the massive U.S. federal deficit, are promising to use the debt ceiling debate to win deep spending cuts next time.

“Our opportunity here is on the debt ceiling,” Republican Senator Pat Toomey of Pennsylvania said on MSNBC, adding Republicans would have the political leverage against Obama in that debate. “We Republicans need to be willing to tolerate a temporary, partial government shutdown, which is what that could mean.”

The coming showdown does not have the potential to plunge the U.S. into recession, economists say. But it could still do some damage.

That last time the government brushed up against the ceiling in August, 2011, it came close to shutting down before lawmakers and the president agreed to a $ 1.2 trillion package of spending cuts in exchange for a Republican agreement to raise the debt ceiling by the same amount.

Uncertainty and stalled negotiations put investors through a ringer. Stock markets around the world fell sharply, and despite the last-minute deal, credit-rating agency Standard & Poor’s down-graded the U.S.’s Triple-A rating.

Much like the fiscal cliff-hanger, uncertainty and lack of confidence hit U.S. – and Canadian – businesses and consumers, and a measurable slump in economic activity followed.

“If anything, because the stakes are a bit lower, it might mean they’re more willing to have a damaging standoff,” Ashworth said.

The International Monetary Fund told the U.S. today that “it is crucial to raise the debt ceiling expeditiously and remove remaining uncertainties about the spending sequester and expiring appropriation bills.”

With files from Star wire services

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