Outlook 2018: Moderate growth

“We’re returning to more normal growth from 2017’s unsustainable pace,” says James Marple, senior economist with Toronto-Dominion Bank.

The main reason for Canada’s surprisingly strong GDP growth was strong consumer spending, up by 3.7% in real (after inflation) terms on the back of “continued strong housing markets, the federal Liberal government’s new child benefit, strong job growth and a pickup in wages,” says Adrienne Warren, senior economist with Bank of Nova Scotia in Toronto.

In addition, retail sales have been enhanced by the Liberals’ middle-class tax cut, which went into effect in mid-2016, notes Avery Shenfeld, chief economist with CIBC World Markets Inc. in Toronto.

However, both housing and consumer spending are expected to cool this year. The average forecast for housing starts among the economists IE surveyed is 198,000 this year and 188,000 in 2019 vs almost 220,000 in 2017. And the average forecast for the consumer price index is 1.9% this year and 2.0% in 2019.

The cooling in housing can be attributed to stricter regulations that took effect on Jan. 1, which makes mortgage approvals more difficult for buyers to get. In addition, mortgage rates are expect to climb. The economists’ average forecast for the rate on 91-day treasury bills is 1.6% at the end of this year and 2.7% as of Dec. 31, 2019, up from a recent 0.9%.

This cooling in the T-bill rates is not expected to result in a significant drop in housing prices nationally, although there may be noticeable drops in the still hot Greater Toronto Area and Greater Vancouver Area.

There are other risks, though, that could affect the housing market. One is the possibility that consumers will step back quickly, in which case there will be significant drops in housing prices. However, economists believe the Bank of Canada (BoC) will react quickly if that happens and stop raising interest rates.

Conversely, another risk is that housing will continue to be strong. That will lead to increased economic growth at first, but could result in higher interest rates than anticipated, which could set the stage for a more severe downturn in housing and a more dramatic economic slowdown.

Another important factor to consider is consumer indebtedness. Consumers have been adding to their debt loads with purchases of houses at elevated prices. That’s OK as long as the houses keep their value and interest rates don’t rise enough to make mortgage payments difficult.

However, Paul Ferley, assistant chief economist with Royal Bank of Canada (RBC) in Toronto, considers household indebtedness as “a key potential downside risk.” Specifically, he believes that the “gradual pace of tightening by the BoC should help, but an unexpected spike in interest rates would be a more worrying development.”

Another factor overhanging the economy is negotiations surrounding the North American Free Trade Agreement (NAFTA). If the U.S. ends both the negotiations and the agreement itself, there would be both an immediate and a longer-term impact. Both the Canadian dollar (C$) and the Mexican peso would tumble vs the U.S. dollar (US$), and companies in both countries would back away from any expansion plans.

“If [NAFTA] ends, there will be a very negative impact on investments initially,” says Benoît Durocher, senior economist with Lévis, Que.-based Desjardins Group in Montreal. The impact on exports will also be negative, but will take more time.

The big question is whether NAFTA will come to an end. The U.S. House of Congress and the Senate have to approve the termination of the agreement, which is by no means certain. There are many Republican members Congress and the Senate who represent states for which trade with Canada is important.

There’s also the question of whether the Canada/U.S. Free Trade Agreement (FTA; in effect prior to NAFTA) would come back into effect if NAFTA is terminated. If both those agreements are dead, then the World Trade Organization’s tariffs will be used – and many of those aren’t much higher than the NAFTA tariffs. Canada’s automobile industry would be the most affected by the termination of NAFTA because that business now comprises a significant amount of cross-border flows. Without NAFTA – and, for Canada, the FTA – tariffs would apply every time any product crossed a border.

For now, the economists assume for their forecasts that NAFTA will remain in place. Says Doug Porter, chief economist and managing director with Bank of Montreal (BMO) in Toronto: “[BMO economists] are assuming NAFTA continues to limp along.”

A less critical question is U.S. tax reforms – and exactly what form they will take and when they will be implemented. In general, the economists predict that these reforms could provide a boost to U.S. growth and negatively affect the competitiveness of Canadian companies selling in the U.S.

“The impact on U.S. growth is likely to be mostly a 2019 story, and it might not be that large if the U.S. Congress clamps down on spending cuts,” says Shenfeld.

In addition, the impact on Canada’s competitiveness “won’t be right away, but will play out over several years,” says Luc Vallée, chief strategist with Laurentian Bank Securities Inc.’s economic research and strategy group in Montreal.

The U.S. economy has been growing above its anticipated growth rate of slightly less than 2% in 2017. Although the estimated 2.3% increase in real GDP for the U.S. in 2017 is significantly less than Canada’s 3%, U.S. GDP growth isn’t anticipated to slow this year. In fact, the average forecast is 2.4% growth in 2018 and a healthy 2% pace in 2019.

Looking across Canada, provincial growth rates are expected to be within a narrower range than in 2017. Last year, the range was from a low of negative 1.4% for Newfoundland and Labrador to an increase of 4.1% in Alberta.

This year, all provinces are expected to show positive growth. For example, RBC’s economics department forecasts growth ranging from a low of 0.6%-0.7% in Nova Scotia and New Brunswick to a high of 2.7% in Saskatchewan.

A key factor in Alberta, Saskatchewan and Newfoundland and Labrador is oil prices. The economists expect the price of Western Texas intermediate oil to average US$56.20 a barrel this year and US$57.80 in 2019 – up from US$51.30 in 2017, which is pretty much unchanged from recent US$57-US$58 targets.

The theory is that no one wants the price of oil to rise much above US$60-US$65 a barrel because that would result in a surge in supply, particularly in the U.S., where it’s easy to increase production of shale oil quickly. Thus, the Organization of Oil Producing Countries and Russia will manage their output to maintain a US$50-US$60 price range.

That’s good news for Canada. Alberta and Saskatchewan have rebounded from recessionary conditions in 2016. Newfoundland and Labrador has had more difficulty, but the RBC forecast anticipates that province will post GDP growth of 2.1% this year and 2.7% in 2019.

Besides Alberta, the provincial leaders in growth in 2017 were British Columbia, at 3.2%; Ontario, at 2.9%; Quebec, at 2.8%; and Manitoba, at 2.6%.

Housing and consumer spending were major factors in B.C. and Ontario, but both provinces have other strengths as well.

B.C. is the province least vulnerable to the potential termination of NAFTA because a significant portion of its exports go to Asia. B.C. benefits from softwood lumber demand in the U.S. – despite the high duties the U.S. imposes on these exports. The price of lumber is high, and because of strong U.S. demand, which is expected to continue during the next two years, Canadian exporters can add the duties to their selling price.

In addition, tourism in B.C. is getting a boost from the low C$, says Krishen Rangasamy, senior economist with National Bank Financial Ltd. in Montreal.

Ontario is the most vulnerable to the termination of NAFTA, but, for now, the province’s manufacturing industry benefits from the low C$ vs the US$, which is making Ontario’s exports more competitive in the U.S. In addition, the loonie is expected to remain around the current US80¢ range for the next two years.

Manufacturing in Quebec and Manitoba also benefits from the low C$.

Both Ontario and Quebec have provincial elections this year, so there could be tax cuts aimed at re-electing the incumbent governments.

Similarly, Rangasamy suggests, B.C.’s minority New Democratic Party government could announce some stimulative measures – and, he adds, the increase in minimum wages in both Alberta and Ontario should increase consumer spending.

However, Marple cautions, higher minimum wages “may weigh on hiring and increase inflation.”

In the Maritimes, P.E.I. is growing the fastest, thanks to increased tourism spurred by the low C$. Nova Scotia’s growth is sluggish, but the province has some major shipbuilding contracts. That’s in stark contrast to New Brunswick, which is without any major projects to boost GDP growth.

The other factor that could boost provincial growth rates is infrastructure. Promised federal spending hasn’t kicked in yet. Vallée cautions that it calls for mostly private spending backed by tax credits, so infrastructure may not be much of a factor.

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