2014-15 Economic Outlook

Canada’s economy is on track to expand by 1.7 per cent in 2013, matching the previous year’s sluggish pace.

Consumer spending and housing activity are proving more resilient than expected, while the slow pace of global growth and ongoing competitiveness challenges have reduced demand for our exports and weighed on manufacturing production. At the same time, businesses remain cautious when it comes to hiring and investing.

Economic growth is expected to improve over the next few years, with real GDP advancing by 2.3 per cent in 2014 and 2.5 per cent in 2015. We look to stronger exports and business capital spending to lead the charge. This is predicated on the expectation that growth will accelerate in the U.S. and gradually pick-up in Europe. When businesses see demand picking up, they will have greater confidence to invest in productivity-enhancing machinery and equipment and expand production capacity.

Don’t Bet Against the Consumer

Consumer spending has remained a stalwart supporter of growth in Canada. Auto dealers are having their best year ever thanks to improving vehicle affordability and very attractive sales incentives, including cash-back offers and cut-rate financing. Housing-related retailing, including furniture and building materials, has also been doing well, driven by ongoing gains in existing home sales.

Going forward, consumers are expected to be a little more cautious in their spending. Household credit growth has slowed substantially and the personal saving rate is well above the average recorded over 2000 to 2012 period.

Housing Still Proving Resilient

Canada’s housing market has continued to be source of strength for the economy. Home sales surged during the spring-summer as homebuyers jumped into the market to beat higher mortgage rates. While national sales have moderated somewhat since then, conditions vary considerably from city to city.

Modestly higher mortgage rates and stretched housing affordability will likely dampen home buyer enthusiasm in 2014, while steady demand from echo boomers (the children of baby boomers) and international migration will provide ongoing support. Prices, sales and starts should remain relatively steady in the year ahead.

On an annual average basis, housing starts are projected to average 185,000 units in 2013 and are forecast at 180,000 units in 2014 and 175,000 units in 2015.

Government Spending

Federal and provincial governments are reining in spending to balance their books. The federal government projects it will return to budgetary balance by fiscal 2015-16. Four provinces are forecasting a balanced budget for fiscal 2013-14, and the rest are targeting balanced books for fiscal 2014-15 with the exception of Ontario; it is aiming to achieve balance by fiscal 2017-18.

With the focus on fiscal restraint, government spending will provide little support to overall growth in 2014 and 2015.

Net Exports

Trade has been a significant drag on economic growth in Canada. Exports have essentially stalled in the past two years and have yet to recover all the ground lost during the recession. The weakness reflects sluggish global demand, over reliance on slower growing markets and ongoing competitiveness challenges.

Looking ahead, Canadian businesses that export to the U.S. (the destination for 73 per cent of Canada’s merchandise exports), including exporters of lumber, raw materials, consumer durables and machinery and equipment, should benefit from ongoing improvement in U.S. consumer demand, residential construction and business investment. A weaker Canadian dollar will also help exporters.

Finally, the euro area economy is seeing the infancy of a frail recovery, but it will be some time before economic conditions normalize. A gradual improvement in economic conditions in Europe will also benefit Canadian exporters as roughly nine per cent of Canada’s merchandise exports go to western European countries. In due time, Canadian exporters will benefit from increased regional diversification as the Comprehensive Economic and Trade Agreement (CETA) agreement between Canada and the European Union is phased in.

Overall, net trade is expected to be a positive contributor to economic growth over the forecast horizon.

Business Leaders in Wait-and-See Mode

Softer corporate profits have affected business capacity to invest, notwithstanding exceptionally strong corporate balance sheets and favourable financing costs.

According to the Bank of Canada’s most recent Business Outlook Survey, many firms continue to report that uncertainty regarding future demand is affecting investment plans, leading them to postpone some projects or to focus on less risky initiatives (for example, repairing and replacing existing equipment). They are also shifting their investment spending toward new or different segments of demand.

Business investment in plant, machinery and equipment is expected to pick up as the global economic landscape continues to improve and uncertainty subsides. Typically, business investment increases following a pick-up in exports, with a bit of a lag (i.e. within two to four quarters).

Finally, non-residential construction is expected to remain fairly robust, and elevated commodity prices should continue to sustain a high level of capital spending in the resource patch.

Inflation Still a Non-Issue

Headline inflation, as measured by the All-items Consumer Price Index (CPI), has generally been falling since May 2011, reflecting a highly competitive retail environment and significant amount of slack (spare capacity) in the economy. The Bank of Canada’s closely watched core measure of inflation, which excludes the eight most volatile components of the CPI (like food and energy) as well as the effect of changes in indirect taxes, has also been on a downward trend since the beginning of 2012.

The Bank of Canada expects both core inflation and total CPI inflation to increase gradually and return to the 2.0 per cent target around the end of 2015.

Faced with below-target inflation, modest growth and slowing household credit growth, the Bank of Canada has held its key policy rate at 1.00 per cent for more than three years and is in no hurry to increase rates. Indeed, it has stopped warning about future rate hikes. In turn, markets have pushed back rate hike expectations. It is now expected that Canada’s central bank will wait until early 2015 to start raising rates.

Dollar Expected to Trend Lower

At the start of 2013, one Canadian dollar bought 1.015 U.S. dollars. Since then, the loonie has lost roughly eight per cent in value against the U.S. dollar, and the near term outlook for the Canadian dollar has weakened. Some of the fundamentals that supported the Canadian dollar over the last several years have eased, most notably portfolio inflows into Canada have slowed and investors have pushed out their anticipated timing of the first rate hike by the Bank of Canada.

As the U.S. Federal Reserve begins tapering its monthly asset purchases, we expect a broadly stronger U.S. dollar and a slightly weaker Canadian dollar. The loonie is projected to generally trade in the low 90 U.S. cent range in 2014. It should receive a boost in 2015 with the first rate hike by the Bank of Canada projected for early 2015. The loonie should strengthen to around 97 U.S. cents by year-end 2015.

In Summary

The International Monetary Fund (IMF) projects global growth at 2.9 per cent in 2013, rising to 3.6 per cent in 2014 and 4.0 per cent in 2015. Much of the pickup in growth is expected to be driven by advanced economies. The Organisation for Economic Co-operation and Development (OECD) expects the world economy to grow at a 2.7 per cent rate in 2013 before accelerating to a 3.6 per cent rate in 2014 and 3.9 per cent in 2015. It, too, expects advanced economies to lead the pack.

Scotiabank Economics noted that “the strengthening in the pace of global economic activity is based on a lengthening list of growth-reinforcing factors and is long overdue. The most important factor is the re-emergence of the United States as the growth leader in the high-income advanced world and its potential to outperform expectations after a multi-year period of underperformance.”

A reinvigorated U.S. (and global) economy should translate into better prospects for Canada’s export sector. To reap the full benefits; however, we need to strengthen our competitiveness, tap new markets and secure and grow our involvement in global supply chains. 

Government can play an instrumental role in strengthening competitiveness by improving the policy setting—for example, reducing the regulatory burden, cutting high marginal personal income tax rates, shifting away from taxing income and profits to taxing consumption, investing in infrastructure and education, and championing unencumbered global trade and investment—however, the onus is on businesses to craft a sustainable competitive advantage to capitalize on these opportunities.

To become more competitive, businesses must relentlessly focus on enhancing their operational efficiency and on reducing costs, continually upgrade the skills of their workforce, constantly improve their products and services, work with government to penetrate new markets, invest in R&D and in information and communications technology, and build internationally recognizable brands.

Because Canada’s exports depend in varying degrees on imported inputs (goods and services), its capacity to import world class inputs is just as critical to its competitiveness and success in international markets as is its capacity to export. As such, managing supply chain relationships and leveraging global supply chains is a business imperative.

By Tina Kremmidas

— Tina Kremmidas is the Chief Economist of the Canadian Chamber of Commerce