Editor’s note: RBC’s most recent economic outlook holds promise for Canadian businesses, as outlined in the following excerpts.
Canada’s economy contracted mildly in both the first and second quarters of 2015, causing a flurry of recession talk. We see this talk as being misplaced given that the depth of the decline was marginal and the weakness was concentrated in the energy sector. As well, the pullback does not appear to be have been sustained as the June GDP gain of 0.5 percent strongly suggests a return to positive growth in the third quarter. Perhaps a more compelling argument against a recession call is that despite the slowing in overall economic activity, Canada’s labour market continued to generate jobs. Year to date, employment gains have been running at 14,000 per month and although the unemployment rate inched up to 7.0 percent in August following six consecutive months of holding at 6.8 per-cent, this reflected a surge in the labour force signaling improved confidence of Canadian workers. Additionally, wages began to accelerate at a much sharper clip starting in May suggesting that if anything businesses were competing for workers not laying them off.
Income Growth And Rising Wealth
Low borrowing rates and ample available credit saw Canadian households ramp up their reliance on borrowing in the first half of 2015, with outstanding debt balances rising at the quickest pace in more than two years. The persistence of historically low interest rates, and to a lesser extent, sustained income gains have kept the relative costs of servicing these debt balances at a record low. If principal payments are included in the debt service calculation, the picture is not as favourable with the debt-to-income ratio standing at a historically elevated level. The rise in the value of both financial and real estate assets however is providing a degree of protection for consumer balance sheets which continue to exhibit solid credit-worthiness with low levels of bankruptcy or foreclosures. We project consumption growth will be firmer in 2016 backed by a lower profile for gasoline prices than previously expected and our expectation that the labour market will continue to generate job growth and wage gains next year.
Housing Market Rally To Continue
Canada’s housing market is poised to post one of its best years on record in 2015 despite the Canadian economy being hit by a significant negative shock (plunge in oil prices) and a spike in condo completions in some markets. Low inter-est rates and the resilient labour market continue to provide substantial stimulus for housing demand. That said, strong momentum is not equally shared across the country with home resale activity plummeting in oil industry sensitive markets (Alberta and Saskatchewan) and soaring in the non-energy intensive exporting provinces, Ontario and British Columbia. Our forecast calls for home re-sales at the national level to rise by 5.0 percent to 505,400 units in 2015, marking the second-highest level on record. Home prices are correspondingly forecast to rise by 4.6 percent, little changed from 4.8 percent registered in 2014. Our forecast assumes a slight easing in resale activity in 2016 as interest rates begin to increase with price gains slowing to 3.2 percent in that year. In keeping with these fore-casts we look for housing starts to slow marginally in 2015 and 2016 although remaining within our estimated range for current demographic requirements of 180,000 to 190,000 units.
Canadian Exports Ramp Up
Slowing trade activity globally and more specifically between Canada and the US contributed to the economy’s soft performance in the first half of the year. The export sector weakness ended abruptly in June when volumes surged and recovered the declines recorded since the beginning of the year. Exports also increased in July with sales of merchandise outside of commodities rising to the highest level since before the recession. The combination of the snap-back in US growth and a substantially weaker Canadian dollar looks to have finally fuelled a pickup in demand for Canadian exports which we expect to continue. We expect the Canadian dollar to remain under downward pres-sure in the near-term which will further improve Canadian companies’ competitiveness. Low commodity prices, especially oil, combined with a widening in interest rate spreads as the Federal Reserve raises its policy rate while the Bank of Canada remains on the sidelines will likely result in the Canadian dollar weakening to 73.5 US cents by the end of this year. The currency is likely to stabilize and recover modestly in 2016 as oil prices trend higher and markets price for the next move by the Bank of Canada to be a rate hike rather than a cut. That said, the currency’s rally is likely to be limited as the Fed continues to be more aggressive in tightening policy and given our forecast for oil prices on a WTI basis to average $57.00 in 2016, from $50.50 this year. We fore-cast the Canadian dollar will gain 5 per-cent against its US counterpart in 2016.
Bank Of Canada To Stay On Sidelines
The Bank of Canada aggressively eased monetary policy this year with the January rate cut followed up with another 25 bps reduction in July. These moves occurred as the Bank incorporated lower investment by energy producers; expectations of slower emerging market growth and the faltering in non-energy exports into their growth projections. The Bank’s updated fore-cast anticipated a decline in real GDP in the second quarter to be followed by a gradual recovery in growth in the second half of the year. Recent data reports, as discussed above, suggest that the economy is performing in line with the Bank’s expectation with the risk, in our view, being that real GDP growth exceeds the Bank’s forecast in the third quarter. Our read of the data is that the economy is already en route to a period of above-potential growth reducing the need for the Bank to ease policy further. Canada’s inflation performance has similarly evolved in line with the Bank’s thinking with the headline rate weighed down by falling energy prices and the core rate remaining slightly above the 2 percent target due to the weaker currency driving up import prices and easing in competitive pressures in some sectors. The head-line rate is forecast to rise to the 2 per-cent target in early 2016 as the weight from the sharp drop in energy prices in 2014-2015 diminishes, core inflation gravitates to the Bank’s target rate (2 percent) as the currency stabilizes and then gradually appreciates. That said, the upside to the inflation outlook will be capped by the recent widening in the output gap which our forecast anticipates will persist until early 2017.
Against this backdrop, we expect the Bank of Canada to hold the overnight rate at 0.5 percent until late 2016. The combination of the economy approaching full capacity and the risk to the inflation outlook shifting to the upside will likely result in the Bank looking to reverse the rate cuts put in place in 2015 with the overnight rate forecast to rise to 1.0 percent by the end of 2016. Ten-year yields are forecast to gradually rise as the inflation rate steadies around the Bank’s 2 percent target and US Treasury yields move higher.
