Construction Industry Forecasts

Canada’s all-items inflation rate in April was +3.3% year over year, the same as in March, according to Statistics Canada. Both months recorded the highest levels for inflation since before the onset of the recession in Q4 2008. In September, 2008 all-items inflation was +3.4%.

In the latest month, the “core” inflation rate – which excludes energy and food – dropped back to +1.6% from +1.7% in March. One of the key sub-component products left out in the calculation of the core rate is gasoline, the price of which rose 26.4% year over year in April.

The Bank of Canada (BOC) has a target for core inflation of +2.0%. That’s the mid-point between the acceptable lower and upper limits of +1.0% and +3.0%. The BOC is currently meeting its target.

Nevertheless, the fact the general price level has shot beyond +3.0% is a cause for concern. One of the biggest dangers with inflation is expectations. An expectation of higher prices can be self-fulfilling.

For example, expectations play a role in labor contract negotiations.

These are tricky times for BOC Governor Mark Carney. Conventional economic theory would advise raising interest rates. That’s also the position being taken by the Paris-based OECD. In its latest economic outlook, the OECD says the BOC should resume raising rates within the next quarter.

However, there are plenty of reasons to be cautious about a return to interest rate hikes after nine months of holding steady at 1.00%. (The BOC upped its overnight rate in three 0.25 percentage-point stages between June 1 and September 8 of last year.)

There are at least four potential problem areas that are holding back more optimistic expectations about the world recovery. 1) ongoing sovereign debt problems in Europe; 2) doubts about the ability and commitment of the Japanese government to undertake necessary post-tsunami re-building efforts; 3) concerns that monetary restraint in parts of Asia may overshoot the mark and slow growth too much; and 4) the worry that consumer and business spending restraint in North America may become excessive in response to high commodity prices, especially gasoline.

There are four countries to particularly monitor with respect to world growth – the United States, Japan, Germany and China.

The OECD projects U.S. real (i.e., inflation-adjusted) GDP growth in 2011 will be +2.7%, followed by +3.3% in 2012. The primary factors holding back the U.S. economy are “household deleveraging and initial steps at fiscal consolidation.” In other words, consumers are cutting back on borrowing for purchases and Washington needs to get its finances in better shape.

Japan’s economic growth is expected to be only +0.3% this year, rising to +1.5% next year. Since public debt exceeds 200% of GDP, reconstruction spending will have to be financed by shifting expenditures (i.e., cuts in non-essentials) and increasing revenues (i.e., higher taxes).

The OECD forecasts Germany will grow +3.1% in 2011 and +2.7% in 2012. It’s good news for all of Europe that Germany’s export-led recovery is being augmented by business investment and private consumption. Employment and wages are on the rise and the slower GDP advance in 2012 will result mainly from the economy bumping up against some capacity restraints.

China’s growth rate is projected to decelerate from +10.0% in 2010 to +9.0% annually in 2011 and 2012. Monetary restraint has been employed to deal with an inflation rate of +5.0% to +7.0%, depending on one’s willingness to accept the veracity of the government’s statistics.

Allowing China’s exchange rate to appreciate would be another means to reduce price pressures, by making imports (especially raw materials) cheaper.

The OECD says Canada will grow by +3.0% in both 2011 and 2012.

There are still few hints of an imminent movement on record-low interest rates south of the border. Even though U.S. all-items inflation in April was virtually the same as in Canada, at +3.2%, there are two primary reasons the Fed will remain unwilling to adopt rate-tightening measures.

First, there is more excess capacity in the U.S. than in most other developed nations. That fact is best illustrated by the six million people who don’t have the jobs they had before the recession.

Second, while the general price level may be on the upswing, due to higher food and fuel prices, it’s hard to work up too much concern and outrage about costs overheating when home prices are continuing to slide.

If Canada moves too far ahead of the U.S. on rates – both in terms of timing and differential – there will be additional upward pressure on the value of the Canadian dollar versus the U.S. dollar.

That’s an extra burden this nation’s manufacturing sector would dearly love to avoid.

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.