Canada 2011: The Hangover
North American & International Economic Highlights
Not surprisingly, the Canadian recovery didn’t play out as advertised. While we did see a spike late last year
and early 2010, the momentum has faded lately, largely as a result of a strong C$ and a softening US
economy. Growth in the second half of the year will be only a fraction of the Bank of Canada’s July Monetary
Policy Report forecast. Early 2011 doesn’t look promising either, which should prompt major revisions in
October’s MPR, forcing the Bank of Canada to defer further tightening.
Exports Will Underperform
Our pared-down outlook for the Canadian economy comes partly as a result of the downbeat export picture.
The second quarter of 2010 provided insights into what lies ahead for Canadian trade. Despite the terms of
trade remaining elevated by historic standards, that hasn’t prevented the current account balance from diving
into red ink.
The Canadian dollar shoulders much of the blame for the disappointing trade performance in the second
quarter. The loonie’s appreciating trend over the last decade has helped shrink our exporters’ market share in
the US from around 20% in 2001 to under 15% today. So much so, that Canada hasn’t been able to fully
capitalize on the American inventory restocking boom in this recovery, with some of that foregone benefit
going to countries taking advantage of their more competitive currencies.
And with sub-2% US growth expected over the second half of this year and first half of 2011, it’s clear that
Canadian exports won’t play a prominent role in the next phase of this recovery. Look for Canada’s trade
sector to underperform the domestic economy this year and next.
Fiscal Withdrawal and the Labour Market
With all hopes resting on the domestic economy, which sectors could be the white knight for Canada next
year? Certainly not the government. The withdrawal of fiscal stimulus next year should limit growth in real
government spending to roughly 1%, the smallest contribution from the public sector to the overall economy
in 14 years. But the impact of fiscal withdrawal runs deeper, and will also negatively impact economic activity
through another channel, namely the labour market.
Note that the public sector accounted for no less than 10% of all jobs created in the economy during the
recovery versus less than 1% in other recoveries. And the construction industry, spurred in part by stimulus
money, single-handedly added a quarter of all jobs since the recovery started, with growth of 10% versus
negative growth at this stage in previous recoveries. Altogether, these two sectors have had a hand in spurring
more than a third of all jobs created in this recovery. And those jobs are relatively high quality (higher-paid)
which explains the significant jump in our employment quality index since early 2010.
With fiscal withdrawal, and the housing market losing ground, the economy will be unable to replace that
sizable contribution from public sector and construction jobs. And it’s unlikely that the new jobs created in
2011 would be of the same high quality—limiting the upside potential in personal income.
Consumers Limited by Wealth Effect
In addition to the cooler labour market, there will be other sources that may act as a drag on consumer
spending next year. It’s no secret that house prices have been falling recently, but less noted is that the
performance of the housing market is already approaching levels seen during the recession. Even a modest 5%
additional drop in average price in 2011, on top of the 6% it already shed from its peak, will lead to a negative
wealth effect of $10 bn, stripping growth in consumer spending by more than a full percentage point.
The same goes for consumer credit, which has been a very important source of consumer spending. Consumer
credit, of which an estimated 30% goes towards direct consumption, is mimicking recessionary trends on a
month-to-month basis. Softness in consumer credit, partly due to supply factors, down from 6% annualized in
the first half of 2010 to 3.5% in the coming 12 months, will also limit consumers’ appetite. Together, the
negative wealth effect from housing and reduced use of credit will pare enough purchasing power from
consumers to limit growth in consumer spending to under 3% next year.
Recent Improvement in Business Investment Will Not Last
While business investment has seen a strong rebound recently, mainly in machinery and equipment, this
bounce is typical of recoveries. We have indeed seen the same trajectory in previous recoveries and in all cases,
the upswing didn’t last long, because most of the improvement at this stage of the cycle is related to
replacement, rather than expansion. With capacity utilization now at only 76%, a number that is inconsistent
with a sustained expansion in investment, don’t expect a significant boost to business fixed investment in
coming quarters.
Business investment in inventories will likely see a similar fate. Relative to past recoveries, inventory restocking
has been brisk thus far, and with the inventory-to-sales ratio still above the pre-recession average the
contribution of inventories in the coming quarters is set to be minimal.
After a two-quarter burst in output late last year and early this year, Canada got a reality check in Q2. The
legacy of the Great Recession won’t disappear overnight. Excess capacity, fiscal withdrawal, de-leveraging, and
a more cautious consumer will weigh on GDP for some time. While the domestic economy will fare better than
exports next year, it will be less than spectacular with softness in virtually all categories, leaving growth for
2011 at a meagre 1.9%.
Two years after the recession, Canada is facing a global economy that still has a hangover from past excesses,
and its local economy has already used up much of the juice from stimulus. The Bank of Canada will, at some
point, resume normalizing interest rates next year, but at a very slow pace, given the slow growth, soft
inflation picture.
spending next year. It’s no secret that house prices have been falling recently, but less noted is that the
performance of the housing market is already approaching levels seen during the recession. Even a modest 5%
additional drop in average price in 2011, on top of the 6% it already shed from its peak, will lead to a negative
wealth effect of $10 bn, stripping growth in consumer spending by more than a full percentage point.
The same goes for consumer credit, which has been a very important source of consumer spending. Consumer
credit, of which an estimated 30% goes towards direct consumption, is mimicking recessionary trends on a
month-to-month basis. Softness in consumer credit, partly due to supply factors, down from 6% annualized in
the first half of 2010 to 3.5% in the coming 12 months, will also limit consumers’ appetite. Together, the
negative wealth effect from housing and reduced use of credit will pare enough purchasing power from
consumers to limit growth in consumer spending to under 3% next year.
bounce is typical of recoveries. We have indeed seen the same trajectory in previous recoveries and in all cases,
the upswing didn’t last long, because most of the improvement at this stage of the cycle is related to
replacement, rather than expansion. With capacity utilization now at only 76%, a number that is inconsistent
with a sustained expansion in investment, don’t expect a significant boost to business fixed investment in
coming quarters.
Business investment in inventories will likely see a similar fate. Relative to past recoveries, inventory restocking
has been brisk thus far, and with the inventory-to-sales ratio still above the pre-recession average the
contribution of inventories in the coming quarters is set to be minimal.
After a two-quarter burst in output late last year and early this year, Canada got a reality check in Q2. The
legacy of the Great Recession won’t disappear overnight. Excess capacity, fiscal withdrawal, de-leveraging, and
a more cautious consumer will weigh on GDP for some time. While the domestic economy will fare better than
exports next year, it will be less than spectacular with softness in virtually all categories, leaving growth for
2011 at a meagre 1.9%.
Two years after the recession, Canada is facing a global economy that still has a hangover from past excesses,
and its local economy has already used up much of the juice from stimulus. The Bank of Canada will, at some
point, resume normalizing interest rates next year, but at a very slow pace, given the slow growth, soft
inflation picture.
Not surprisingly, the Canadian recovery didn’t play out as advertised. While we did see a spike late last year
and early 2010, the momentum has faded lately, largely as a result of a strong C$ and a softening US
economy. Growth in the second half of the year will be only a fraction of the Bank of Canada’s July Monetary
Policy Report forecast. Early 2011 doesn’t look promising either, which should prompt major revisions in
October’s MPR, forcing the Bank of Canada to defer further tightening.
The second quarter of 2010 provided insights into what lies ahead for Canadian trade. Despite the terms of
trade remaining elevated by historic standards, that hasn’t prevented the current account balance from diving
into red ink.
The Canadian dollar shoulders much of the blame for the disappointing trade performance in the second
quarter. The loonie’s appreciating trend over the last decade has helped shrink our exporters’ market share in
the US from around 20% in 2001 to under 15% today. So much so, that Canada hasn’t been able to fully
capitalize on the American inventory restocking boom in this recovery, with some of that foregone benefit
going to countries taking advantage of their more competitive currencies.
And with sub-2% US growth expected over the second half of this year and first half of 2011, it’s clear that
Canadian exports won’t play a prominent role in the next phase of this recovery. Look for Canada’s trade
sector to underperform the domestic economy this year and next.
year? Certainly not the government. The withdrawal of fiscal stimulus next year should limit growth in real
government spending to roughly 1%, the smallest contribution from the public sector to the overall economy
in 14 years. But the impact of fiscal withdrawal runs deeper, and will also negatively impact economic activity
through another channel, namely the labour market.
Note that the public sector accounted for no less than 10% of all jobs created in the economy during the
recovery versus less than 1% in other recoveries. And the construction industry, spurred in part by stimulus
money, single-handedly added a quarter of all jobs since the recovery started, with growth of 10% versus
negative growth at this stage in previous recoveries. Altogether, these two sectors have had a hand in spurring
more than a third of all jobs created in this recovery. And those jobs are relatively high quality (higher-paid)
which explains the significant jump in our employment quality index since early 2010.
sizable contribution from public sector and construction jobs. And it’s unlikely that the new jobs created in
2011 would be of the same high quality—limiting the upside potential in personal income.
spending next year. It’s no secret that house prices have been falling recently, but less noted is that the
performance of the housing market is already approaching levels seen during the recession. Even a modest 5%
additional drop in average price in 2011, on top of the 6% it already shed from its peak, will lead to a negative
wealth effect of $10 bn, stripping growth in consumer spending by more than a full percentage point.
The same goes for consumer credit, which has been a very important source of consumer spending. Consumer
credit, of which an estimated 30% goes towards direct consumption, is mimicking recessionary trends on a
month-to-month basis. Softness in consumer credit, partly due to supply factors, down from 6% annualized in
the first half of 2010 to 3.5% in the coming 12 months, will also limit consumers’ appetite. Together, the
negative wealth effect from housing and reduced use of credit will pare enough purchasing power from
consumers to limit growth in consumer spending to under 3% next year.
bounce is typical of recoveries. We have indeed seen the same trajectory in previous recoveries and in all cases,
the upswing didn’t last long, because most of the improvement at this stage of the cycle is related to
replacement, rather than expansion. With capacity utilization now at only 76%, a number that is inconsistent
with a sustained expansion in investment, don’t expect a significant boost to business fixed investment in
coming quarters.
Business investment in inventories will likely see a similar fate. Relative to past recoveries, inventory restocking
has been brisk thus far, and with the inventory-to-sales ratio still above the pre-recession average the
contribution of inventories in the coming quarters is set to be minimal.
After a two-quarter burst in output late last year and early this year, Canada got a reality check in Q2. The
legacy of the Great Recession won’t disappear overnight. Excess capacity, fiscal withdrawal, de-leveraging, and
a more cautious consumer will weigh on GDP for some time. While the domestic economy will fare better than
exports next year, it will be less than spectacular with softness in virtually all categories, leaving growth for
2011 at a meagre 1.9%.
Two years after the recession, Canada is facing a global economy that still has a hangover from past excesses,
and its local economy has already used up much of the juice from stimulus. The Bank of Canada will, at some
point, resume normalizing interest rates next year, but at a very slow pace, given the slow growth, soft
inflation picture.
ORTH AMERICAN & INTERNATIONAL ECONOMIC HIGHLIGHTS