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Spring 2010 comments on Canada's economic outlook

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Alex Carrick

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Alex Carrick is Chief Economist for Reed Construction Data. He specializes in economic forecasting and statistical services.

Economists

The outlook for interest rates in Canada is a little more hawkish than in most other countries. Core inflation (which ignores energy and food prices) in this country has already exceeded the Bank of Canada’s (BOC) target of 2.0%, although not by much. The United States, on the other hand, has a core inflation rate that has dropped to only 1.3%. The BOC is therefore likely to take action sooner than the Federal Reserve. This has implications for the overall Canadian economy and for many of the provincial economies that are dependent on currency values, the price of commodities and international trade.

The outlook for interest rates in Canada is a little more hawkish than in most other countries. Core inflation (which ignores energy and food prices) in this country has already exceeded the Bank of Canada’s (BOC) target of 2.0%, although not by much. The United States, on the other hand, has a core inflation rate that has dropped to only 1.3%. The BOC is therefore likely to take action sooner than the Federal Reserve. Australia is the other nation that has been moving its policy-setting rate higher to head off future inflationary problems. Like Canada, Australia is a resource-based economy that will benefit from the resurgence in Chinese, South Asian and, to a lesser degree, Indian economic growth.

There is a major problem with raising Canadian interest rates too early. Interest rates moving higher in Canada ahead of the U.S. will put upward pressure on the value of the loonie compared with its south-of-the-border counterpart. The loonie has already reached parity. It may be the case that international currency traders have already factored in a pre-emptive move on interest rates by the Bank of Canada.

By this time next year, Canada’s target overnight rate is likely to be about 2.00%, on its way to a long-term historically neutral position of 3.00% to 3.50%. A neutral bank rate is when it is neither excessively stimulatory nor too restrictive. The current 0.25% level is an unprecedented low and there are serious worries that start to fester if it is left at that level too long. Interest rate effects often don’t show up in the overall economy for a year or longer. Then it’s too late to correct the mistake. That’s when the right move seems obvious in hindsight.

Current low rates have certainly had a profound effect on housing starts. In April of 2009, home starts in Canada dropped to only 112,000 units seasonally adjusted and annualized. Since then they have recovered to nearly 200,000 again. They averaged 222,000 units per year from 2002 through 2008. Several of Canada’s largest banks have recently nudged mortgage rates higher despite the BOC holding the line.

The strength in new home starts is a response to a much more active resale market, after the dog days of early 2009. Important for the Canadian economy has been the fact that the job loss total here is now only 250,000 versus the peak employment level in October 2008. The U.S. registered a substantial job increase (+162,000) in March 2010 for the first time since March 2007, but still stands in deficit by 8.2 million jobs.

Canada’s employment picture has been much stronger than almost anywhere else in the developed world. In fact, Canada never did see much of a decline in the important category of service sector jobs in the recession. Toronto’s financial community deserves a lot of the credit. The biggest banks did not have to retrench as happened elsewhere on account of collateralized debt obligation (CDO) failures and the credit crunch. The more conservative nature of Canadian banks stood them in good stead as global storms swept away other financial institutions.

The regional economies in Canada are now awaiting a further pickup in U.S. economic activity. The U.S. housing sector has dropped off the map. The mortgage foreclosure and bank-owned home problem has spread to the “prime” sector from the “sub-prime” and “teaser-rate” sectors. This has happened because so many formerly well-paid individuals have been thrown out of work and can’t meet their monthly payments. The U.S. recovery so far (+5.6% real GDP growth in Q4 09 vs +5.0% in Canada) has been led by a downward adjustment in inventories – so that new sales need production to be cranked up – and a surge in exports after a decline in the value of the greenback versus the Euro and the Yen.

However, there has been a sudden reversal in expectation about the value of the U.S. dollar due to continuing deflation in Japan and the effect of the Greek debt crisis on the Euro. The luster on both the yen and the Euro has been tarnished while some shine has been restored to the greenback. Nevertheless, as far as the loonie is concerned, its value will come from commodity prices (especially oil), international disparities in interest rates and the fact that the federal and provincial governments are not as financially strapped (i.e., lower debt to GDP ratios) as are Washington and the states below the 49th parallel. The massive deficit spending that is underway in the U.S. has to be a long-term concern.

Western Canada is still experiencing the largest population gains in the country. British Columbia has been the fastest growing province for the past two quarters. Alberta has slipped to fourth position. Saskatchewan and Manitoba hold second and third-place rankings. Ontario’s population growth is below the national average. Most of the Atlantic Provinces have been adding people for the first time in many years.

Analysts are a little perplexed about the climb in the international price of oil. It is currently in abundant supply with tankers in some major international ports filled to the brim. Nevertheless, a U.S. economy that will eventually be moving from recovery to expansion will help to spur on demand and in India and China, tremendous increases in the car-driving populations can only mean the need for more energy imports.

The world price of oil has moved to $87 USD. This is still below its peak of $145 in July 2008, but well up from its low of $45 in early 2009. As the price of oil climbs, Alberta’s prospects improve. The government in Edmonton has promised to revise its royalty regime to encourage more investment. Alberta’s Tories recognize that a number of factors will be restraining oil and gas activity in the province versus the past. Environmental issues in the Tar Sands are gaining more traction. New natural gas fields are being developed in many regions in both Canada and the U.S. thanks to technological advances that allow horizontal drilling in shale rock. Texas, Louisiana and Oklahoma offer particularly fertile ground. What many people don’t know is that Alberta is even more dependent on natural gas exploration and drilling than it is on oil.

The B.C. economy may suffer some post-Olympics letdown. That will be quickly overcome once more U.S. housing foundations are dug, pulling B.C. lumber exports across the border. Also B.C. is an active participant in the high-tech sector that sits along the Pacific Coast, with Seattle and San Jose as the hubs. The high-tech sector has weathered the economic hard times relatively okay. It experienced nothing like the job losses that occurred during the dot.com collapse in 2001-2002. Firms in a wide range of industries have counted on advanced software and hardware to provide them with output even as they dismissed production workers. The Vancouver-Whistler Winter Olympics show-cased B.C. to the world and there will be follow-up benefits in the often forgotten but quite important tourism and accommodation industries.

Toronto also has a large high-tech sector and it will continue to be relatively vibrant. Toronto is currently in the middle of the pack among urban centres in Canada for year-over-year employment growth. But it is well down in the ranking of unemployment rates with a figure of 9.4% compared to the national level of 8.2%. Toronto’s population isn’t increasing at as fast a percentage as in many other parts of the country, but the city is still adding 100,000-plus people per year. That’s a lot of individuals, a whole new census metropolitan area on its own each year. By 2030, the population of the city is expected to move as high as nine million from a current figure slightly in excess of five-and-a-half million.

The auto sector will have a much better year in 2010 than in 2009, especially south of the border. This will help the operations of the Detroit Three – Ford, GM and Chrysler – especially now that the latter two have re-organized and more financially-solvent ownership. The Japanese carmakers on the outskirts of Toronto are performing reliably, with Toyota apparently overcoming many of its recall and resulting customer-relations problems, and Honda announcing a forthcoming manpower increase for its assembly operations in Alliston just north of Toronto.

The recent Ontario budget announced five-year delays for several rapid transit projects in the city. This cuts back on the engineering construction outlook, but several other large transit projects will still be charging ahead, including subway work, a GO-line past Pearson airport and major highway expansions. Furthermore, the city has certain commitments that it must meet to host the 2015 Pan-Am Games. The city will not wish to look paltry in light of the success that Vancouver had while standing in the world’s spotlight during the Winter Olympics.

The higher-valued Canadian dollar will continue to present a hurdle for Ontario manufacturers, but they are adjusting. Low capacity utilization rates will help to keep costs down. The high-valued loonie also serves to reduce the number of foreign visitors. On that score, Americans are becoming more familiar with their need to obtain proper documentation, usually in the form of a passport, when they venture abroad. This will see some increase in visitors to Toronto’s and Ontario’s primary live-entertainment sites, including Stratford and Niagara-on-the-Lake.

Office building construction in Toronto is likely to stay depressed for several years. The length of the commercial downturn will not be as great as in the 1980s, however, since there was not the same degree of overbuilding during the latest expansionary period as then, when several major developers went bust (e.g., Olympia and York). Large commercial properties in Canada are now mainly in the hands of giant pension funds, often with considerable government backing. It should be added that there is one other Canadian city presently overbuilt in offices, Calgary.

Four of Canada’s Top 10 project starts in March were located in Ontario and mainly in the greater Toronto regional district. They were all residential multi-unit properties (condos and townhomes). The introduction of the harmonized sales tax (HST) on July 1st might take some of the steam out of residential markets, but that remains to be seen. Home prices have demonstrated considerable resiliency. Speaking of investments, the Toronto Stock Exchange has recovered 50% from its trough position and that’s good for investor and consumer confidence.

According to the latest employment survey conducted by Manpower Inc., the net employment outlook in Ontario for Q2 2010 versus Q1 2010 is +11%. That is the percentile difference in the percentage of total firms surveyed saying that they will be adding staff versus the percentage saying that they will be making cuts. The good news with respect to Ontario’s employment picture is led by firms in finance, insurance and real estate (+19% net employment outlook) and in wholesale and retail trade (+15%). Ontario usually accounts for about 40% of Canada’s GDP.

Canada’s real (inflation-adjusted) gross domestic product (GDP) declined 2.6% in full-year 2009. In 2010, it is expected to flip over to a gain of 2.5% to 3.0%. A similar increase will also occur in 2011 as world recovery/expansion becomes more firmly entrenched. Canada’s prospects will continue to be closely tied to those of the United States. But for both countries, and even more for Canada than the U.S., the growth of emerging nations will play an increasing role through raw materials demand. Canada is one of the few more prosperous nations, along with Australia and Brazil, which can easily supply those needs. The coming growth cycle for this nation offers many reasons to be optimistic.

Alex Carrick

Find Canadian construction-related economic articles in Canadian Construction Market News and in the Economic Outlook section of Daily Commercial News. Mr. Carrick also has a lifestyle blog that can be reached by clicking here.

by Alex Carrick

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