CANADA – NOTING THE POSITIVES, BUT ALSO THE RISKS
Economists often get a bad rap for seeing the world
as exclusively a glass half empty. Given this reputation,
it is not surprising that economics is dubbed the ‘dismal
science.’ Still, we are also known to call a spade a spade
when we see it. We must do just this when we say that the
Canadian economy ended last year on a more positive note
than we had last predicted. This momentum represents a
solid hand-off into 2012. What’s more, financial markets
so far this year have enjoyed the absence of volatility that
was the dominant theme for 2011. The S&P/TSX composite
index has gained 2.3% so far in January, which is in stark
contrast to the 10.8% loss posted last year.
Our latest tracking shows the Canadian economy grew by
2.0-2.5% in the fourth quarter annualized, an upside from our
December forecast of 2.0%. An important part of the story
has been Canadian consumers. We saw evidence of this in
the retail sales’ numbers for November. They grew monthover-
month by 0.3% in real terms and an even stronger 0.5%
in nominal terms. With Black Friday and Cyber Monday
increasingly becoming important calendar events on this side
of the border, retailers were hoping to capitalize on greater
mall traffic as consumers stocked up for the holiday season.
We will have to wait and see if November’s gain comes at a
cost to December. However, data so far suggest that there is
an upside risk to our consumer expenditure forecast for the
fourth quarter of 2011. The 2012 economic outlook should
also be helped by higher consumer and business sentiment,
readings confirmed by separate releases this week.
Also this week, the U.S. Federal Reserve (Fed) injected
further monetary stimulus into its economy by telling markets
and investors that it plans to keep its interest rates at
near-zero levels until late 2014, or eighteen months longer
than was previously stated. In the fallout of the announcement,
U.S. and Canadian bond yields fell across the curve.
In terms of currency, the loonie reached parity with the U.S.
dollar yesterday for the first time since November 2011.
Ontario, Saskatchewan and New Brunswick also took advantage
of the increased appetite for long-term, fixed-rate
products and raised a total of $1.8 billion yesterday.
With the change in the Fed call, Bank of Canada Governor
Carney will need to reconsider when to lift domestic
interest rates. The Governor has repeatedly said that there
are limits to how much Canadian rates can diverge from
those in the United States. In setting monetary policy
decisions, Governor Carney must manage the domestic,
export-based economy as well as implement policy to meet
the inflation rate target. He must also take into account the
heightened international risk and uncertainty imbedded in
the current global economic outlook. While the next interest
rate announcement is not till March, we believe there is
now increased pressure to delay the hike from the end of the
first quarter in 2013 to the end of the second quarter. When
the central bank does raise rates, we expect it to return to
equilibrium more gradually than our previous forecast. We
now have the overnight rate increasing to 2.00% (in quarter
percentage point increments) by the end of 2013. The growing
interest rate spread between Canada and the U.S. should
spur moderate price appreciation of the Canadian dollar, but
the currency is not poised to deviate far away from parity.
Business investment is expected to be a bright spot in
the outlook given the low borrowing conditions and strong
currency. We also forecast that Canadians will continue to
spend, creating positive pressure for the domestic side of our
national forecast. This spending behaviour does not come
without repercussions. Canadian households are already
posting record debt levels. What’s more, the longer low
rates persist, the more difficult it will be to reverse course.
If consumers continue to spur heightened real estate activity
as well, there could be a larger and steeper correction for
the housing market than the 10-15% we have incorporated
into our forecast over the next few years. Given where this
note has ended, perhaps it’s true that economists cannot say
sunny and rosy for too long. At the same time, it’s prudent
to constantly look for risks, such that there are no surprises
when and if they come to materialize.
Sonya Gulati, Economist, 416-982-8063