GROWTH HEADWINDS WILL KEEP BOC IN HOLDING PATTERN
Kevin Carmichael delves into the rationale behind not altering rates any time soon.
Canada’s economy is deeply flawed, but it appears to have at least one characteristic that will keep it in the big leagues: resiliency.
Gross domestic product grew at an annual rate of 1.3 per cent in the third quarter, Statistics Canada reported on Friday. That should mute the recession talk, while at the same time bolstering the arguments of those who say Canada needs to work on its competitiveness game. The Bank of Canada reckons the economy can run at an annualized pace of about 1.7 per cent without overheating, so clearly there’s some work to do.
For now, the central bank will probably continue to leave that work to others. The GDP numbers favour continuing the holding pattern that the Bank of Canada entered a year ago.
Governor Stephen Poloz and his deputies will end their latest deliberations with a new policy statement on Dec. 4. When they last met at the end of October, they said they were concerned about exports and business investment, and therefore would be paying “close attention” to the engines that will have to push the economy through those headwinds, namely consumer spending, housing and fiscal policy.
Exports during autumn were about as bad as you’d expect given the trade wars and the weakest global economic growth since the Great Recession. Overall, shipments abroad declined from the second quarter, and services, which have been a source of consistent strength for several years, only expanded 0.1 per cent after increasing 2.8 per cent in the previous three months.
That matters because total exports are the equivalent of about 32 per cent of Canada’s
$2.1 trillion GDP. The domestic market isn’t big enough to keep the economy growing at a significant rate, but when executives see a backlog of international orders, they are supposed to invest in order to keep up with demand. The trade wars are choking such investment around the world by creating uncertainty about the future.
Remarkably, Canadian business investment in non-residential structures, machinery, and equipment increased at an annual rate of 9.5 per cent in the third quarter, reversing a seven-percent drop in the second quarter, and recovering the momentum sparked by an 18-per-cent surge at the start of the year.
The post-crisis oil boom drove quarterly business investment to a record $230 billion in the fourth quarter of 2014 — 30 per cent higher than at the end of 2007. The surge was bubbly, making comparisons with those years problematic. Still, business spending has been disappointing for much of the past decade, forcing the central bank to keep interest rates unusually low. Companies invested $187 billion in the third quarter, the most since the second quarter of 2018, and the third-highest total since the end of 2015, according to Statcan.
“The first sign of resilience is business investment,” said Sébastien Lavoie, chief economist at Laurentian Bank Securities, adding that upward revisions to the second-quarter numbers “will please (Bank of Canada) officials.”
The second sign is the housing market, which has recovered smartly from a wobble at the start of the year, when tighter lending rules squeezed speculators and forced less creditworthy borrowers to choose between smaller homes or saving for larger a down payment.
But demand recovered, especially after the interest-rate cuts by the United States Federal
Reserve rippled through global credit markets. Residential investment grew at an annual rate of 13.3 per cent last quarter, adding to a 5.5-per-cent increase in the second quarter, Statcan said.
Poloz and his deputies will welcome further evidence that they and other authorities appear to have guided Canada’s frothy housing market to a soft landing. However, it might also give them pause, as they are sensitive about rekindling the credit binge that drove household debt to record levels.
Poloz acknowledged that the Governing Council considered cutting interest rates in October as insurance against an escalation of the trade wars, but ultimately decided against it because of Canadian households’ propensity to borrow the maximum banks will give them.
That debt now represents an important vulnerability because it would exacerbate the pain of an economic downturn caused by the trade wars or some other external factor. It also could cause the downturn if households start devoting more of their incomes to debt payments, and less to purchasing goods and services.
Consumption recovered somewhat in the third quarter, increasing 0.4 per cent from the second quarter, compared with growth of only 0.1 per cent in the April-july period. Still, the quarterly average in data going back to 1961 is 0.8 per cent, so it’s fair to say the domestic economy has lost step. The savings rate was
3.2 per cent, the highest since the autumn of 2015, when the rate was 4.1 per cent. Employment and wage-growth has been strong, so an increased emphasis on savings suggests spending priorities are shifting.
There are worrisome items in the GDP report, to be sure. Exports are a red flag for the short term. The mediocre investment numbers present longer term worries, as they suggest Canadian executives haven’t been doing enough to remain competitive. Spending on intellectual property increased for the second consecutive quarter, but the most recent amount, $34 billion, is 16 per cent lower than the peak reached at the start of 2008.
But for the most part, the world has unfolded essentially the way the Bank of Canada thought it would a month ago. Applying the parameters that the central bank has set, there is no obvious reason to alter interest rates in December, or even in the foreseeable future.
Financial Post