The economies of Canada and the U.S. are expected to grow at a healthy pace over the next two years, despite high oil prices, further increases in short-term interest rates and, in Canada’s case, a high dollar.
Economists surveyed by Investment Executive
may not form a consensus but collectively they expect U.S. economic growth to decelerate in 2006 to 3.3% and in 2007 to 2.9%, from 3.6% in 2005. Canadian growth is expected to stay about the same this year, at 2.9%, and come down marginally in 2007, to about 2.8%.
This resiliency is somewhat surprising, but high oil prices — most of those surveyed are assuming oil prices of US$50 a barrel or higher — don’t seem to have the same bite they used to have. Although Leo de Bever, executive vice president of global investment management at Manulife Financial Corp. , and Adrienne Warren, senior economist at Bank of Nova Scotia, both in Toronto, say the recent level of US$60 a barrel, if sustained, poses a risk to U.S. and Canadian consumer spending, most others think there won’t be a serious problem until the price hits US$70-US$80.
Indeed, Lloyd Atkinson, a financial and economic consultant in Toronto, doesn’t think the price of oil will really hurt until it hits US$100-US$120 a barrel. Similarly, George Vasic, chief strategist at UBS Securities Canada Inc. in Toronto, puts the point at which it could really bite at US$100. And Paul Ferley, assistant chief economist at Bank of Montreal, also in Toronto, thinks oil prices probably won’t significantly impede growth in Canada until the price hits US$80-$100, but concedes it could be a problem in the U.S. once it hits the US$70-US$90 range. That’s because U.S. consumers won’t have the offset of higher wages that Canadians in the oil- and gas-producing regions will.
There’s less consensus on interest rates than on growth. While economists are confident the U.S. Federal Reserve Board and the Bank of Canada will do what’s necessary to keep their economies growing, they differ on what levels of interest rates will be appropriate to do that.
The most optimistic are Atkinson, BMO’s Ferley and John Anania, assistant chief economist at Royal Bank of Canada in Toronto. They all see Canada growing by 3% or better in both 2006 and ’07. In the case of Atkinson and Ferley, that’s on the back of even stronger economic growth in the U.S. Neither are worried that inflationary pressures could force the Fed to increase interest rates sharply to take out price pressure.
Anania, on the other hand, thinks inflation will be an issue in the U.S., and he expects U.S. three-month T-bills to be 5% at the end of this year and 5.8% as of Dec. 31, 2007, which will slow growth south of the border to 2.7% from 3.4% in 2006. He doesn’t see inflation as a threat in Canada, and the more benign interest rate scenario explains the better Canadian growth in 2007.
Only two others expect U.S. 91-day interest rates to reach 5%. Carlos Leitao, strategist and chief economist at Laurentian Bank Securities in Montreal, sees rates reaching 4.8% at the end of this year and 5.5% as 2007 draws to a close. But, like Anania, he doesn’t see the Bank of Canada following suit.
Manulife’s de Bever, on the other hand, does see the Bank of Canada catching up to the Fed in 2007, raising its overnight rate to 5% by the end of 2007, given U.S. inflation of 3%. He thinks the Fed will reach 5% by the close of this year and hold that level through 2007 — as long as U.S. inflation is about 3%. This will slow Canadian growth to 2.5% in 2007 and 2.3% this year. The U.S. will withstand the higher rates better than Canada, with growth of 3.1% in 2006 and 2.8% in 2007. The high C$ and high oil prices will further affect manufacturing and structural weakness will hit autos.
There are others who think 5% interest rates will have a negative impact on the U.S., as well as Canada, and think the central banks will act to reduce rates. Doug Porter, deputy chief economist at BMO Nesbitt Burns Inc. in Toronto, sees the Fed discount rate going to 4.75% at the end of March from the recent 4.25%, then coming down later in the year. He forecasts U.S. three-month T-bills at 4.3% at yearend and 4.1% at the end of 2007. The Bank of Canada will follow, he says, but with a bit of a lag.
@page_break@Laurentian’s Leitao; UBS’s Vasic; Stephane Marion, assistant chief economist at National Bank Financial Ltd. in Montreal; and Carlo Gomez, economist at TD Bank Financial Group in Toronto, are also expecting the Fed to lower rates later this year, reflecting a slowing U.S. economy. Gomez sees annualized quarterly growth in the fourth quarter of just 2.3%. NBF doesn’t have a forecast yet for 2007 but Marion is assuming a further decline in rates in early 2007, increasing again as the U.S. economy picks up steam in the second half. Vasic’s U.S. three-month T-bill forecast of 3% as of the end of 2007 is the lowest; he sees U.S. GDP growth of 2.6% next year.
Although no one is forecasting a recession, a number of economists do think it is a significant risk in 2007: TD’s Gomez says there is a less than 20% chance of recession; NBF’s Marion, 30%; and Nesbitt’s Porter, 30%-35%. UBS’s Vasic says it could only happen if U.S. long rates go above 5%-6%.
Long rates have been surprisingly low and most expect them to remain so. Only Atkinson and BMO’s Ferley think 10-year Canada government bond rates will be 100 basis points or more higher than short rates in both countries at the end of this year and next. Scotia’s Warren sees the spread at 100 bps in Canada but only 70 bps-80 bps in the U.S. Vasic expects the spread in Canada to be 100 bps in 2007 but only 30 bps in the U.S. that year.
Ferley says long rates didn’t move up earlier because of skepticism about the extent of the Fed’s tightening and the level of liquidity in the system. Skepticism has waned, he says, and capital investment, especially in the U.S., will absorb the extra liquidity.
Factors that would hold down long rates include large purchases of U.S. treasuries by Asian central banks and corporate pension funds that are investing the additional monies required to bring their plans to financial viability.
There’s considerable disagreement about where the C$ is going. The range of forecasts is US78¢-US90¢ for the end of this year and US80¢-US94¢ as 2007 draws to a close. Atkinson’s prediction is the lowest, based on his belief that there will be downward pressure on the U.S. dollar as long as central banks and other investors are prepared to buy U.S. investments. And he sees no reason for that to stop: U.S. equities are attractive, and foreign central banks will support the US$ because of the dire implications for their exports should it go down significantly.
Royal Bank’s Anania, TD’s Gomez, Laurentian’s Leitao and UBS’s Vasic all include a US$ crisis as a risk to their outlooks.
Like others, they think the huge and growing U.S. current account deficit, coupled with a high fiscal deficit, will once more put downward pressure on the US$ once the Fed stops raising rates. They also see upward pressure on the C$ because of strong resources prices. It’s no coincidence that Vasic’s US89¢-plus C$ is accompanied by the highest oil price forecast, averaging more than US$60 both years.
What remains a little surprising is that the high C$ hasn’t hurt the non-resources economy more. After all, it was only four years ago that the C$ was at US62¢. Central Canadian manufacturers were expected to have trouble competing in export markets and against imports. Yet Central Canada continues to grow at a respectable pace, albeit much slower than the booming resources-rich provinces.
BMO’s Ferley, Nesbitt’s Porter, TD’s Gomez and UBS’s Vasic think much of the adjustment to the higher C$ has taken place, although Vasic warns that there’ll be more as the C$ continues to climb. The others believe, however, there’s more to come. The plus is that the current level puts more emphasis on productivity in order to stay competitive.
Productivity is a major theme of the federal government’s November fiscal update and is a major part of the Liberal election platform. Canada’s record has not been good. Some economists think higher productivity is coming. BMO expects it to grow at about 2% a year for the next couple of years. Gomez finds solid evidence of higher productivity in manufacturing.
Certainly, the high C$ should drive the need to stay competitive. One good thing about the high loonie is that it makes imports less expensive — and most of the machinery and equipment Canadian manufacturers use is imported. NBF’s Marion is encouraged by the recent “marked increase” in spending on M&E. Scotia’s Warren also sees some encouraging signs, “underpinned by increased capital investments and focused tax relief.”
Besides a US$ crisis, other risks include soaring oil prices; a significant slowing in China (which has been a major driver of global growth and of the high commodity prices, both of which have benefited Canada, a collapse in U.S. real estate (some think prices have reached speculative levels) and a collapse of General Motors Corp. and/or Ford Motor Co. and the parts manufacturers that supply them. Any of these would probably cause a recession in the U.S., which would reverberate around the world.
A collapse of a major U.S. automaker would be particularly bad for Ontario, a major assembler, and could produce a truly dual Canadian economy, with recession in the center and continued good growth in the oil-producing regions.
Other Canadian-centric risks include further increases in the C$ pushing manufacturing competitiveness to the crisis point and the possibility that the Quebec separatist threat could return, which would unnerve financial markets and probably lead to an increase in interest rates to counteract downward pressure on the C$. IE
Solid growth likely
- By: Catherine Harris
- January 4, 2006 January 4, 2006
- 10:27