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In a recent speech in Windsor, Ontario, Bank of Canada governor Mark Carney said that given the risks of a renewed U.S. slowdown and amid slow consumption and housing activity in Canada, “any further reduction in monetary policy stimulus would need to be carefully considered.”
Carney’s remarks came the same day new data showed Canada’s gross domestic product contracted for the first time in 11 months by 0.1 per cent in July.
While the Bank of Canada has raised interest rates three times in the past four months, most recently on Sept. 8, and the bank’s key overnight lending rate is currently 1.0 per cent, during the same time in the United States, the Federal Reserve has held the policy rate at almost zero.
“While Canada’s circumstances and the discipline of the inflation target dictate a different stance than in the United States, there are limits to this divergence,” he said.
The recession may be over, he warned, but it’ll still a long road back to a strong economy. Domestically, Canada’s relatively strong bounce-back from recession has been supported by housing expansion and personal consumption, two factors that can’t continue, Carney said.
“This cannot continue. With Canadians working, but not as much as they would like, they have been borrowing. Real household credit expanded rapidly throughout the recession, in contrast to previous downturns, and has continued to grow through the recovery. Canadian households have now collectively run a net financial deficit for 37 consecutive quarters. That is, their investment in housing has outstripped their total savings for over nine straight years. In effect, households are demanding funds from the rest of the economy, rather than providing them, as had been the case through the 1960s, 1970s, 1980s and 1990s.”
Externally, he said, the world is facing a restructuring that could take 10 years and subdue growth in the advanced economies. Even Canada’s supposedly strong jobs recovery is not as shining as it looks. The unemployment rate remains high at 8.1 per cent and many of the jobs created since July have come in the public service and what he called involuntary part-time work.
No Double Dip for Europe
Last Thursday, the European Commission released its European Economic Sentiment Indicator, and contrary to what many analysts had anticipated, specially on this side of the Atlantic, it showed that consumer and business confidence are at its highest point in Europe since March 2008.
In spite of widespread debt problems, the Eurozone Economic Sentiment Indicator, or ESI, rose to 101.3 in July from an upwardly revised 99.0 in June, pulled by strong growth in Germany.
German businesses clearly perceive their situation as improving. The IFO Business Climate Index, an early indicator for economic development in Germany, saw its largest jump in July since German unification in 1990.
Europe’s economic releases suggest the region is not headed for a double dip. Though Europe’s sovereign debt problems present a huge financial and, consequently, economic risk, financial markets have nonetheless demonstrated an impressive resilience. Indeed, their behavior under this strain speaks to a significant, fundamental healing.
“All in all, the strong pick-up in economic sentiment in July confirms that the spillover effects from the sovereign debt crisis to the overall economy have been limited thus far,” said ING Bank economist Martin van Vliet.
There are other positive indicators, such as the TED spread (the gap between Treasury bill and interbank lending rates, and a good indicator of liquidity), which has only widened in this crisis, from 20 basis points (bps) to about 40 bps. Some widening was to be expected in the face of European uncertainties, but matters are still a long, long way from the 460 basis-point spread recorded during the 2008–2009 crisis.
Similarly, junk bond spreads have widened, from some 600 bps over Treasuries earlier this year, to 700–750 bps, as the European problems have become evident. Though an unsurprising reaction to the European credit scare, these spreads are a far cry from the 2,100 bps they reached in 2008–2009.
Meanwhile, issues continue to get sold on bond and money markets, and even bank lending has shown some tentative signs of flowing again.
The federal budget from a global perspective
The federal budget introduced on March 4th will be forgotten within a week. In many ways this budget should be seen as a transitory budget, with no major initiatives. All the difficult decisions were postponed until the 2011 budget.
But what’s very clear at this point is that from a global perspective, the stimulus and bailouts of yesterday will turn into the fiscal tightening of tomorrow. The US might turn out to be the most difficult case. The issue is not only that the US current budget deficit is close to 10% of GDP, but also the composition of the deficit. Note that “pure” expenditure growth (that is program spending) by the government was not very large and this boost was offset by a de-facto spending cuts by state and local governments. So at the end of the day over the past year, we have seen only $40-$50 billion of pure spending—nothing to write home about. The vast majority of “spending” (close to $500 billion) was in the form of transfer to financial institutions, individuals and lower taxes. Note, for example, in US, all the growth in personal income currently is due to transfer payments and lower taxes. Wage income is actually falling. The point here is that when it comes to taxes and transfer payments, it is much more difficult (politically speaking) to cut when compared to pure fiscal spending.
Also remember that in both the US and Canada, the ability to cut the deficit in the 1990s was largely helped by falling interest rates, and in the case of Canada, a very weak dollar. Both factors are not at play in the current situation. Accordingly, look for any improvement in the fiscal situation to be limited.
The practical implication here is that huge budget deficits cannot co-exist with record low interest rates. Something will have to give. And this something must be interest rates. The new global fiscal reality suggests that long-term interest rates will probably rise faster than short-term rates in the coming 2-3 years—leading to a notable steepening in the yield curve.
In this context, Greece will try to sell enough bonds next week to finance the close to $30 billion of debt that is about to mature in April and May. Note that after these two months, the refinancing situation of Greece will improve for a while with much less debt expected to mature in the following months. So they have to go through the next two months before getting a break. At this point it is far from clear that the market will be willing to absorb this amount of Greek debt—so look for some volatility next week.
The US labour market is still unable to create jobs and start reversing the trend that cost no less than 8 million jobs during the recession. But if you look at overall manufacturing activity in the US, you will see a very different picture with an impressive rebound in production activity. In fact, the manufacturing sectors on both sides of the 49th parallel are showing signs of life. But the improvement in the US is not only stronger, but also much more capital-intensive. The practical implication of the more capital-intensive manufacturing rebound south of the border is that despite the strong Canadian dollar, manufacturing employment in Canada will probably rise faster than in the US in the near term. However, given the increased prevalence of better- capitalized and more efficient production facilities stateside, Canadian manufactures will find it even more difficult to compete when the dust settles.
Benjamin Tal
Senior Economist
Recovery to pick up, Bank of Canada says
CBC News
The Bank of Canada has slightly raised its projection for growth in 2011, saying the Canadian economy will benefit from a faster-than-expected recovery in the U.S. this year.
The central bank said Thursday it expects the Canadian economy to grow by 3.5 per cent next year, up from its previous projection of 3.3 per cent.
It says GDP will grow by 3.5 per cent in the first quarter this year from Q4 of 2009. While that’s down from the 3.8 per cent quarter-over-quarter growth it was forecasting three months ago, the central bank now expects the economy to expand by 4.3 per cent in the second quarter and 4.0 per cent in the third quarter and 3.8 per cent in the final quarter of the year.
The Q2, Q3, and Q4 growth estimates are all increases from the central bank’s projections made last October.
“Export growth is projected to be somewhat stronger than was expected last October, owing to a more favourable outlook for the U.S. economy, particularly in the sectors that figure most importantly for Canadian exporters,”
the bank said in its quarterly Monetary Policy Report.
The Bank of Canada substantially hiked its estimate for U.S. economic growth this year from 1.8 per cent to 2.5 per cent.
It says overall growth in Canada this year will come in at 2.9 per cent — down a tenth of a percentage point from its estimate of three months ago.
Still, the overall tone of the new outlook was slightly more upbeat than three months ago.
“Economic growth is expected to become more solidly entrenched over the projection period as self-sustaining growth in private demand takes hold.”
Canada fared better in downturn
The central bank says the Canadian economy shrank by 2.5 per cent in 2009. That’s larger than its previous estimate of 2.4 per cent.
But even though real GDP in Canada contracted for three consecutive quarters, “the magnitude of the downturn was more modest than in other major advanced economies.”
The central bank estimated that Canada’s GDP fell 3.3 per cent from peak to the trough of the recession — less than most other advanced economies, even though exports plunged 20 per cent.
“Canada’s relatively solid economic performance, in spite of this trade shock, reflects the resilience of Canadian household demand. Consumer spending barely declined in Canada,”
“Canada has suffered less than many other countries, partly because of its sound banking system and relatively strong household and corporate balance sheets, and also because of the speed and scale of monetary policy actions.”
Employment levels likely bottomed last summer, according to the central bank.
“The deterioration in the labour market appears to have stopped,” Bank of Canada governor Mark Carney told a news conference. But the bank noted that its recent surveys have found that “ongoing weakness in the labour market is nevertheless evident.”
The jobless rate is now hovering around 8.5 per cent.
Inflationary pressures grow
Inflationary pressures in Canada are building slowly. The central bank now expects total CPI inflation in the first quarter will be 1.6 per cent, up two-tenths of a percentage point from its estimate in October. It projects inflation will jump to 1.9 per cent by the fourth quarter of this year, up three-tenths of a point from its last projection.
Core inflation, which excludes the more volatile items in the consumer price index, has been “slightly higher” than expected recently, the bank said. “Nevertheless, considerable excess supply remains, and the bank judges that the economy was operating about 3.25 per cent below its production capacity in the fourth quarter of 2009,” it said.
The outlook for global economic growth this year and next is “somewhat stronger” than it was in October, the bank added. But it warned that “the recovery continues to depend on exceptional monetary and fiscal stimulus, as well as extraordinary measures taken to support financial systems.”
On Tuesday, the Bank of Canada left its key lending rate at a rock-bottom 0.25 per cent and reaffirmed its commitment to keep it at that level through June, assuming inflation does not become a concern.