US steps back from 'fiscal cliff', averting New Year tax hikes

In a dramatic session in the early hours of New Year's Day, senators moved to reduce the economic impact of the fiscal cliff.

The United States senate yesterday acted to pull the country back from the brink of the fiscal cliff, averting huge tax rises and spending cuts that some feared would prompt a new economic downturn.

In a dramatic session in the early hours of New Year's Day, senators voted 89 to 8 to raise taxes on high earners and delay for two months part of the US$110 billion (Dh404.04bn) in spending cuts that would otherwise have kicked in yesterday.

The breakthrough paves the way for helping to avoid the risk of serious economic slowdown or even a recession in the US, which observers warned was at stake without a deal. The long-awaited agreement came too late to meet congress's own deadline of the end of New Year's Eve for passing laws that avert the fiscal cliff. But with global markets closed yesterday the impact of the delay was muted.

To ensure its passage, the legislation will need agreement from the house of representatives, which could prove tricky as some conservative Republicans feel the deal leans too heavily towards tax increases rather than federal spending cuts. The house was due to meet at noon eastern standard time yesterday.

President Barack Obama urged the house to follow the senate's example. "While neither Democrats nor Republicans got everything they wanted, this agreement is the right thing to do for our country and the house should pass it without delay," he said.

"There's more work to do to reduce our deficits, and I'm willing to do it. But tonight's agreement ensures that, going forward, we will continue to reduce the deficit through a combination of new spending cuts and new revenues from the wealthiest Americans." Yesterday's deal would raise tax rates on individuals earning more than $400,000, or $450,000 for jointly filing couples.

It would also raise taxes on capital gains and dividends for those households to 20 per cent, up from 15 per cent. The value of personal exemptions and itemised deductions would also be limited under the compromise, while setting the estate tax rate at 40 per cent on estates over $5 million.

As expectations rose about a compromise in the offing, US markets rallied late on Monday. Investors have remained wary in recent weeks as the countdown ticked closer to the fiscal cliff deadline.

But failure to pass legislation in the coming days is likely to reignite market anxiety over the risk of a fresh recession in the US. Heading over the fiscal cliff could lead to an economic slowdown early in the year, according to the congressional budget office.

"Clearly, if there is no resolution in the US fiscal cliff, we expect weakness in developed markets and as usual that would have a knock-on effect here," said Julian Bruce, the Dubai-based head of institutional trading at EFG Hermes Holding.

Politicians still face a tricky task to tackle the budget deficit, which has raised debt levels to US$16.4 trillion. February is likely to be dominated by wrangling over raising the debt ceiling.

In trading yesterday, Saudi Arabia's Tadawul index gained 0.9 per cent to close at 6,860.01 on news of the agreement in the US Senate.

"The Saudi market now reacted positively to the news about the new agreement reached, even though it isn't final," Mohammed Al-Omran, financial analyst and president of the Gulf Center for Financial Consultancy in Riyadh told Bloomberg.

"We don't know the reaction of the House. If it rejects the agreement, capital markets will go back to square number one."