OTTAWA – Wait until next year.
It’s a familiar refrain for sports teams, but the premise is getting old for Canadians awaiting the return of an economy that can be counted on for jobs, solid incomes and financial security.
As far back as 2010, the Bank of Canada held out the prospect of better times in the year ahead. But unexpected events — whether it was a tsunami in Japan, a debt crisis in Europe, or political shenanigans in Washington — always took the shine off the optimism.
“If you were looking for a theme song for the Canadian economy, it would either be ‘With a Little Help from my Friends,’ or, alternatively, Led Zeppelin’s ‘The Song Remains the Same,’ ” says Craig Alexander, TD Bank’s chief economist.
He says we’re still waiting for a hand-off from consumer-driven growth.
“We are going to eventually get this rotation toward exports and business investment and away from real estate and consumer spending. We said that would happen in 2013. It didn’t happen. Now we’re saying it is going to start next year,” Alexander said.
TD, like the Bank of Canada and a consensus of economists, is estimating growth will rebound to about 2.3 per cent in 2014. That would follow two years of sub-par growth at 1.7 per cent in 2012 and an estimated 1.7 per cent growth this year.
The improvement foreseen for 2014 is not much of a bump and won’t lead to massive job creation and steep income growth. But the difference between 1.7 per cent and 2.3 per cent is important.
The Bank of Canada believes economy has the “potential” to grow about two per cent. At 1.7 per cent, the economy has underachieved its potential whereas, at 2.3 per cent, the economy can eliminate slack and head toward full recovery.
The central bank thinks 2015 will see the gap close further with 2.6 per cent growth, enabling the economy to return to health by the middle or the end of that year.
The other important distinction is the composition of growth.
According to the central bank and others, 2014 will be the year the economy finally enters the zone of what Bank of Canada governor Stephen Poloz calls self-generating, self-sustaining “natural growth.”
That is critical because Canada, for the past three years, has experienced a kind of un-natural recovery.
Yes, it has recouped all it lost during the recession in terms of output and jobs, but a persistently low inflation reading and continuing slack in production capacity suggest something has not been quite right.
Growth was achieved primarily at first because federal and provincial governments pumped tens of billions of dollars into the economy — all of it borrowed.
The Bank of Canada — as well as its U.S. counterpart — has also kept interest rates at or near rock bottom, encouraging businesses and households to borrow money and spend.
Snatch away the stimulus measures and Canada, some say, would most likely still be in recession.
CIBC chief economist Avery Shenfeld there was nothing fundamentally amiss about Canada’s domestic economy before 2008 when the world’s financial system was dealt a severe blow by a meltdown in the U.S. real estate, which spread to banking and other industries.
While Canada’s economy initially emerged from the 2008-9 global recession in relatively good shape, it has limped along more recently amid weakened demand for many of the country’s major exports.
“Part of the reason Canada hasn’t seen the lift in capital business spending is because the rest of the world has disappointed us,” Shenfeld said.
“Interest rates have been low, financing has been available, but unless you are sure the product demand is going to be there, it’s hard to trigger a boom in capital spending. So a brighter global economy could see a return in capital spending in the resource in sector, which is part of that rotation that’s been missing.”
That’s where a little help from our friends, particularly the United States where 75 per cent of exports end up, will go along way to curing Canada’s ills, say analysts.
Optimism for 2014 is tied to how quickly the U.S. recovers and how much that boosts Canadian exports. The Royal Bank is among the most optimistic, pencilling in a 2.6 per cent expansion next year, and 2.7 the year after that, which will more quickly close the output gap and get the Bank of Canada to raise interest rates in 2015.
Exporters will also benefit from a swooning loonie, analysts say, because, by comparison, the U.S. economy will outperform Canada’s. The loonie has already lost about six per cent in value in the past year and now hovers around 94 cents US. By many estimates, it could be at least as low as 90 cents by the end of 2014.
With all these factors in Canada’s favour, it’s a wonder the economy won’t do better. But the Bank of Canada has noted that exporters haven’t kept pace, given the rebound in the United States, so they won’t likely benefit as much in 2014 as they have historically.
Part of the reason, says governor Poloz, is that the country lost about 9,000 exporting companies in the aftermath of the 2008-09 recession.
Alexander, TD’s chief economist, lists other factors: an increase in the number of right-to-work states in the U.S. that have brought down labour costs; a shale oil and gas revolution; and low gas prices that have decreased energy input costs for a lot of U.S. manufacturers.
“And we’ve had really strong productivity growth in the U.S.,” Alexander added. “So U.S. manufacturing is far more competitive than it was before and that makes it much tougher for Canadian exporters.”
The consensus view assumes that the modest pick up in exports, which will lead to companies investing in machinery and equipment in order to become more competitive exporters, won’t be counterbalanced by a retrenchment in the household sector and in housing.
Taking the contrary view, as does David Madani, the chief analyst at Capital Economics, leads one to the conclusion that 2014 won’t be any different from 2012 and 2013 in terms of aggregate economic growth — even if the composition is healthier.
With the housing market overbuilt and household debt at record levels — 164 per cent of annual aftertax income — Madani expects a bad year for the construction industry and a slowdown in consumer spending, which makes up the majority of the economy.
“So you have a situation where weakness in housing and slower household consumption growth is now offsetting the improvement in exports and perhaps business investment,” Madani says.
Rather than improving, Madani thinks the economy will deteriorate further to 1.5 per cent growth, which may cause the Bank of Canada to cut interest rates further and even push Finance Minister Jim Flaherty off his austerity drive — although he admits that’s a long shot.
Madani’s advice. Wait till next year and, by next year, he means 2015 or even 2016. By then there will have been a correction in housing and global demand may be strong enough to make more of a difference to Canada.