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TD Economics
March 19, 2013
Canadas economic engines sputtered in the second half of 2012, as the pace of economic growth was cut in half between the end of 2011 an 2012. This country is not unique in this predicament, as global growth slowed broadly and fiscal uncertainty in the U.S. weighed on business confidence and investment south of the border. But, that is yesterdays news. Looking ahead at this years performance, we expect Canadas economy to gradually shift into a higher gear. Unfortunately, it wont feel like the economy is roaring ahead, as CHART 1. ECONOMIC GROWTH TO SHIFT domestic sources of growth most notably the housing sector GEARS GRADUALLY are set to slow (see Chart 1). 4 Contribution to Real GDP Growth, % Forecast Overall, we expect the Canadian economy to grow at a sub-par 3 1.6% pace on an annual average basis this year, before accelerating 2 to 2.6% in 2014. Due to the weak hand off from 2012, the 2013 1 growth tally belies a stronger average quarterly pace of roughly 0 2%. The theme of slowing final domestic demand in 2013 remains intact, as the housing sector moderates, consumers keep spending -1 Consumers, Govt. & Housing restrained in the face of high debt levels and governments wrestle -2 with deficits. In the wake of softer commodity prices, particularly Bus. Investment & Net Exports -3 lower oil prices, and a poor year for corporate profits, business Real GDP growth -4 investment is also expected to be weak in the near term. 2006 2007 2008 2009 2010 2011 2012 2013 2014 At the moment, Canada continues to wait for stronger exports Source: Statistics Canada; Forecast by TD Economics as at March 2013 and business investment to take over from consumers and govCraig Alexander, SVP & Chief Economist, 416-982-8064 Derek Burleton, VP & Deputy Chief Economist, 416-982-2514 Leslie Preston, Economist, 416-983-7053
TD Economics | www.td.com/economics
ernments to drive growth. Patience should be rewarded as private sector demand in the U.S. gathers speed later in 2013, providing a lift to exports, and eventually business investment.
Canada needs a little help from its friends
Year-over-year % change
Canadas economic fortunes have long been tied to our neighbour to the south, and the sluggish U.S. recovery has left an indelible mark on Canadas export performance. Exports account for about one-third of Canadas GDP and roughly three quarters of exports are bound for the U.S. That share was greater than 80% at times prior to the recession. This has left Canadian exports below their pre-recession levels (see Chart 2) and they represent the missing piece in Canadas economic recovery thus far. Therefore, the most encouraging data for Canadas economic outlook since our last forecast comes from south of the border. The U.S. housing sector is on the mend. Prices are in positive territory on a year-on-year basis and housing starts are starting to show upward momentum. Manufacturers are becoming more optimistic after being hit by fiscal uncertainty in the U.S. last year, which should help lift investment. Auto sales are also expected to grow at a healthy pace over the forecast horizon. All of these factors are very positive for Canadian exporters who send a great deal of lumber, autos and parts and machinery south of the border. Looking at the aspects of the U.S. economy that are the most important to Canada, as measured by the U.S. Activity index, suggests that Canadas exports should notably improve, particularly in 2014 (see Chart 3). In fact, net exports should make a positive, albeit small, contribution to growth this year, after having been a drag on the economy
CHART 2. EXPORTS STILL BELOW PRERECESSION LEVELS
120 110 100 90 80 70 2006 2007 2008 2009 2010 2011 2012 2013 2014
Source: Statistics Canada; Forecast by TD Economics as at March 2013
Forecast
2004
2006
2008
2010
2012
2014
Source: Bureau of Economic Analysis, Statistics Canada, Federal Reserve, Bank of Canada. Forecast by TD Economics as of March 2013
in 9 of the last 10 years. However, the U.S. does still have considerable fiscal drag to deal with in the near term. We dont expect exports to really strengthen until the second half of 2013, as the U.S. economy gains momentum.
Until then, challenges weigh on businesses
Until U.S. economic growth strengthens, Canadas businesses will continue to face various headwinds constraining growth in corporate profits and business investment. Much hay was made last year about dead money on corporate balance sheets in Canada; that businesses were not investing enough as they sat on piles of cash. However, with perfect hindsight businesses had good reason to be cautious. Corporate profits were down 9% year-on-year in the fourth quarter of 2012 (see Chart 4), and that backdrop bodes ill for business investment this year.
CHART 4. FLAGGING COMMODITY PRICES HIT CORPORATE PROFITS
60 40 20 0 -20 -40 -60 04:Q1 Year/Year % Chg. TD Commodity Price Index Corporate Profits Forecast
06:Q1
08:Q1
10:Q1
12:Q1
14:Q1F
TD Economics | www.td.com/economics
According to Statistics Canadas survey of investment intentions, capital spending is only expected to advance by 1.7% nominally in 2013. That marks a dramatic pullback from the 8.5% average annual pace posted between 2010 and 2012. Notably, the resource sector (mining and oil & gas extraction) expects to decrease capital spending by 2.7% this year. Despite all the worries about pipeline constraints and continued price discounting for oil produced in Western Canada, investment intentions in Canadas unconventional oil sector (primarily oil sands) actually held up fairly well. Resource sector investment weakness is concentrated in mining, particularly metals. On the plus side, investment intentions showed strength in other sectors of the economy, like utilities, transportation and warehousing and wholesale and retail trade. Still, we expect business investment to grow at a very modest 2.4% pace in 2013, reducing its contribution to economic growth compared to earlier in the recovery. Commodity prices arent expected to accelerate much this year, holding back revenues in the resource sector, and Canadian manufacturers continue to face competitive pressures like a strong Canadian dollar. These developments, combined with Canadas relatively poor productivity performance, mean that unit labour costs are rising faster here than in the U.S. (see Chart 5) a negative for the sectors competitiveness. A relatively strong loonie does lower the cost of investing in productivity-enhancing equipment, and plans for capital spending on machinery and equipment actually held up relatively well for 2013, which is a good sign for business productivity.
Consumers and governments have already scaled back, now housing cooling
Consumer and government spending were key pillars of strength earlier in the recovery, but their contributions to growth have already faded considerably. Consumers did finish 2012 on a relatively strong note, but there are signs that the pace of spending will soften. Growth in consumer credit has slowed to roughly match income growth, auto sales are already at lofty levels and arent expected to have too much more upward momentum, employment gains are expected to moderate, and a cooler housing market will weigh on purchases of housing-related durables. Add it all up, and consumer spending is expected to continue its recent lacklustre trend pace of roughly 2%. Delving deeper into Canadas real estate market, housing starts have already slowed significantly, and we expect residential investment to be a drag on growth in 2013. Lower residential investment and a cooling housing market have ripple effects throughout the economy. Over the past ten years, a booming housing market made a substantial contribution to Canadas economy through various channels: direct and indirect impacts of residential construction, purchases of housing-related consumer goods, and the wealth effect of higher home prices on spending. The wealth effect refers to the notion that as households see the value of their homes rise, they feel wealthier and choose to spend more and save less. TD Economics estimates that the total lift to the economy from the combination of these effects added 0.8 percentage points to annual GDP growth on average over the past ten years (see Chart 6). Looking ahead, it is likely to take away about 0.1 percentage points per year on
CHART 6. HOUSING SET TO WEIGH ON ECONOMY
3.0
2.0
110
1.0
100
Canada U.S.
0.0
-0.02
90
-1.0 2001 2003 2005 2007 2009 2011 2013
*Includes direct & indirect impact of residential construction, housing-related durables spending and the wealth effect Source: Statistics Canada, Forecast by TD Economics as at March 2013
TD Economics | www.td.com/economics
average over the next three years, representing a massive swing in the economic fortunes tied to the housing sector. Canadian average home prices are expected to provide only a 2% nominal return over the next decade, a marked slowing from an average annual pace of 5.4% over the past thirty years. That greatly reduced wealth effect will make home-equity fuelled spending much less of a factor going forward. That said, we are not calling for a housing market crash, and while a slower housing sector will be a weight on Canadas economy going forward, it will not sink it. We are currently in the middle of government budget season, and the slowdown in economic growth has hit nominal government revenues. As the federal government and most provinces struggle to get back in the black, expenditure restraint continues to be the theme. While public sector investment intentions looked strong, they are only intentions, and as budgets are drawn up, plans may not come to fruition. Overall much like consumers, governments do not have the capacity to be a major economic growth contributor over our forecast horizon.
With inflation cool, rate hikes on ice
Looking ahead, our modest economic growth forecast will keep core inflation well shy of 2% over the next year. That will give the new Bank of Canada Governor, who will arrive in June, plenty of time to learn the ropes before needing to take interest rates higher. We now anticipate only a half percentage point rise in the overnight rate in the final quarter of 2014, and a further half percentage point in 2015. The Bank has also become a lot more dovish in its latest interest rate statement, citing that the current considerable monetary stimulus will remain in place for a period of time. With rate hikes farther out on the horizon and little upward momentum in commodity prices, the Canadian dollar has recently lost steam alongside many other currencies versus the U.S. dollar. We have lowered our outlook for the Canadian dollar this year (see table page 6), which should help ease competitive pressures somewhat in the short-term. But, the relief is likely only temporary; the loonie is expected to return above par once again as Bank of Canada rate hikes become more imminent in 2014 (see Chart 7).
Bottom Line
Inflation has cooled right along with Canadas economy over the past year, and the core measure (total CPI excluding the most volatile items) is running at a mere 1% yearon-year as of January. While it is no surprise that sub-par growth has produced a greater degree of economic slack in the economy, the extent of softness in inflation has been unexpected. Rock-bottom interest rates have keep mortgage interest costs subdued, and the Bank of Canada has cited heightened competitive pressures among retailers as a source of softness in core inflation.
CHART 7. OVERNIGHT RATE AND THE CANADIAN DOLLAR
5.0
% CAD/USD Forecast
1.2
4.0
CAD$ (rhs)
1.1
Canadas economy has always been dependent on the fortunes of the U.S., and this is particularly evident now that domestic engines have downshifted. The missing piece in Canadas economic recovery has been exports, which have not regained their pre-recession levels, due to the sluggish recovery south of the border. Fortunately, it looks like the dark cloud that has been hanging over Canadas outlook finally appears to have a silver lining. Private demand in the U.S. is gaining momentum, particularly as the housing sector strengthens. This should eventually be an unambiguous positive for Canadas export sector. In the meantime, however, the U.S. economy still has considerable fiscal drag to contend with, leaving Canadas growth sub-par in the near term as a slowing housing sector and fatigued consumers leave domestic growth subdued. But, we continue to expect stronger growth south of the border to push Canada out of its economic doldrums come 2014. Craig Alexander SVP and Chief Economist 416-982-8064 Derek Burleton, Vice President and Deputy Chief Economist 416-982-2514 Leslie Preston, Economist 416-983-7053
4
3.0
1.0
2.0
BoC Overnight Rate (lhs)
0.9
1.0
0.8
0.7
TD Economics | www.td.com/economics
-13.0 -1.7 1.2 1.0 0.4 7.5 2.5 1.3 2.9 1.8
5.3 -0.2
4.1 1.2
13.5 -2.0
5.7 3.4
1.0 1.8
5.5 1.6
6.0 2.3
6.2 2.7
7.0 2.6
5.5 2.8
6.5 2.7
6.2 2.8
7.2 1.5
4.7 1.7
6.3 2.6
--0.6
--2.1
--2.7
-54.9 -71.7 -72.2 -69.0 -58.0 -56.2 -51.7 -48.6 -49.3 -47.1 -45.0 -42.2 -66.9 -53.6 -45.9 -3.0 -4.0 -4.0 2.9 -3.8 -4.1 -3.1 3.4 -3.0 3.5 -2.7 3.9 -2.6 4.1 -2.6 4.5 -2.4 5.0 -2.3 5.7 -2.1 6.0 -3.7 -2.7 -2.9 0.6 -2.3 4.6 13.9 1.9 4.5 1.3 1.4 252 7.0 4.1 4.1 1.8 1.8 169 1.1 -16.3 -17.1
-----9.1 --0.8 1.9 1.4 1.6 278 --2.8 --0.9 1.2 ---0.5
----3.7 --1.7 3.8 1.1 1.1 202 --3.2 --1.3 1.3 --1.0
----5.3 --1.9 4.7 1.2 1.6 285 --4.3 --1.9 1.9 --1.1
14.9 14.2 14.1 13.9 14.0 13.9 13.9 13.9 13.9 13.9 14.0 14.0 14.3 13.9 2.0 1.1 0.6 0.8 36 7.4 2.9 3.7 2.3 2.1 205 1.2 0.8 0.9 2.1 2.6 113 7.3 4.8 4.5 1.6 2.0 231 1.5 1.5 3.6 0.8 0.6 26 7.3 2.2 4.2 1.2 1.5 222 0.5 0.8 1.9 2.1 2.4 103 7.2 1.3 3.8 0.9 1.2 202 -0.5 1.0 2.4 0.3 1.3 55 7.0 2.2 3.7 0.9 1.0 172 -0.5 1.7 4.2 1.7 1.0 44 7.2 3.0 3.7 1.2 0.8 180 -0.1 1.6 4.1 1.2 0.9 42 7.2 3.5 3.7 1.2 1.0 175 0.2 1.7 4.6 1.2 1.4 62 7.2 4.1 3.7 1.3 1.3 172 1.0 1.5 4.6 1.5 1.6 71 7.2 4.5 3.9 1.6 1.6 171 1.1 2.0 4.5 1.2 1.5 67 7.1 4.3 4.0 1.8 1.8 170 1.2 1.9 4.8 1.0 1.4 63 7.0 4.2 4.1 1.9 1.9 168 1.2 1.9 4.7 1.0 1.9 85 6.8 4.0 4.2 1.9 1.9 165 1.1 1.3 3.1 1.0 1.2 201 7.3 3.4 4.0 1.5 1.7 215 0.7 1.5 3.1 1.2 1.4 242 7.1 2.6 3.7 1.1 1.0 175 0.2
F: Forecast by TD Economics as at March 2013 Source: Statistics Canada, Bank of Canada, Canada Mortgage and Housing Corporation, Haver Analytics
TD Economics | www.td.com/economics
INTEREST RATE OUTLOOK
2012 Q1 CANADA Overnight Target Rate 3-mth T-Bill Rate 2-yr Govt. Bond Yield 5-yr Govt. Bond Yield 10-yr Govt. Bond Yield 30-yr Govt. Bond Yield 10-yr-2-yr Govt Spread U.S. Fed Funds Target Rate 3-mth T-Bill Rate 2-yr Govt. Bond Yield 5-yr Govt. Bond Yield 10-yr Govt. Bond Yield 30-yr Govt. Bond Yield 10-yr-2-yr Govt Spread CANADA - U.S SPREADS Can - U.S. T-Bill Spread Can - U.S. 10-Year Bond Spread 0.84 -0.12 0.78 0.07 0.87 0.08 0.87 0.02 0.85 -0.05 0.80 -0.10 0.75 -0.10 0.75 -0.10 0.75 -0.10 0.65 -0.20 0.65 -0.20 1.00 -0.30 0.25 0.07 0.33 1.04 2.23 3.35 1.90 0.25 0.09 0.33 0.72 1.67 2.76 1.34 0.25 0.10 0.23 0.62 1.65 2.82 1.42 0.25 0.05 0.25 0.72 1.78 2.95 1.53 0.25 0.10 0.25 0.75 1.90 3.05 1.65 0.25 0.15 0.28 0.90 2.05 3.15 1.77 0.25 0.20 0.30 1.00 2.20 3.40 1.90 0.25 0.20 0.35 1.10 2.30 3.50 1.95 0.25 0.20 0.40 1.25 2.50 3.75 2.10 0.25 0.30 0.50 1.40 2.70 3.95 2.20 0.25 0.40 0.60 1.55 2.80 4.05 2.20 0.25 0.40 0.80 1.75 3.00 4.10 2.20 1.00 0.91 1.20 1.57 2.11 2.66 0.91 1.00 0.87 1.03 1.25 1.74 2.33 0.71 1.00 0.97 1.07 1.30 1.73 2.32 0.66 1.00 0.92 1.14 1.38 1.80 2.36 0.66 1.00 0.95 1.00 1.35 1.85 2.50 0.85 1.00 0.95 1.10 1.45 1.95 2.55 0.85 1.00 0.95 1.15 1.55 2.10 2.70 0.95 1.00 0.95 1.20 1.60 2.20 2.75 1.00 1.00 0.95 1.25 1.70 2.40 2.95 1.15 1.00 0.95 1.35 1.80 2.50 3.10 1.15 1.00 1.05 1.50 1.95 2.60 3.15 1.10 1.50 1.40 1.70 2.05 2.70 3.25 1.00 Q2 Q3 Q4 Q1F 2013 Q2F Q3F Q4F Q1F 2014 Q2F Q3F Q4F
F: Forecast by TD Bank Group as at March 2013; All forecasts are end-of-period; Source: Bloomberg, Bank of Canada, Federal Reserve.
Exchange rate to U.S. dollar Japanese yen Euro U.K. pound U.S. dollar Japanese yen Euro U.K. pound JPY per USD USD per EUR USD per GBP USD per CAD JPY per CAD CAD per EUR CAD per GBP
f: Forecast by TD Bank Group as at March 2013; All forecasts are end-of-period: Source: Federal Reserve, Bloomberg, TDBG
Crude Oil (WTI, $US/bbl) Natural Gas ($US/MMBtu) Gold ($US/troy oz.) Silver (US$/troy oz.) Copper (cents/lb) Nickel (US$/lb) Aluminum (Cents/lb) Wheat ($US/bu)
F: Forecast by TD Bank Group as at March 2013; All forecasts are period averages; Source: Bloomberg, USDA (Haver).
TD Economics | www.td.com/economics
CONTACTS AT TD ECONOMICS
Craig Alexander Senior Vice President and Chief Economist mailto:craig.alexander@td.com CANADIAN ECONOMIC ANALYSIS Derek Burleton, Vice President and Deputy Chief Economist derek.burleton@td.com Sonya Gulati Senior Economist, Government Finance and Public Policy sonya.gulati@td.com Diana Petramala Economist, Real Estate diana.petramala@td.com Francis Fong Economist, Financial francis.fong@td.com Dina Ignjatovic Economist, Autos, Commodities and Other Industries dina.ignjatovic@td.com Leslie Preston Economist, Macro leslie.preston@td.com Jonathan Bendiner Economist, Regional jonathan.bendiner@td.com U.S. & INTERNATIONAL ECONOMIC ANALYSIS Beata Caranci, Vice President and Deputy Chief Economist beata.caranci@td.com James Marple Senior Economist james.marple@td.com Martin Schwerdtfeger Senior Economist, International martin.schwerdtfeger@td.com Michael Dolega Economist michael.dolega@td.com Thomas Feltmate Economist thomas.feltmate@td.com Ksenia Bushmeneva Economist ksenia.bushmeneva@td.com
TO REACH US Mailing Address 55 King Street West 21st Floor, TD Tower Toronto, Ontario M5K 1A2 Fax: (416) 944-5536 mailto:td.economics@td.com
This report is provided by TD Economics. It is for information purposes only and may not be appropriate for other purposes. The report does not provide material information about the business and affairs of TD Bank Group and the members of TD Economics are not spokespersons for TD Bank Group with respect to its business and affairs. The information contained in this report has been drawn from sources believed to be reliable, but is not guaranteed to be accurate or complete. The report contains economic analysis and views, including about future economic and financial markets performance. These are based on certain assumptions and other factors, and are subject to inherent risks and uncertainties. The actual outcome may be materially different. The Toronto-Dominion Bank and its affiliates and related entities that comprise TD Bank Group are not liable for any errors or omissions in the information, analysis or views contained in this report, or for any loss or damage suffered.