External forces dampening Canadian economy in 2007: TD Economics
Canada’s economic slowdown in 2007 will stem
from external demand rather than domestic spending according to TD Economics.
Its Chief Economist and Senior Vice President, Don Drummond, stated: “The
problem will be with the American not Canadian consumer.”
The December issue of the TD Quarterly Economic Forecast states the
Canadian economy will expand at an average 2.1 percent pace per quarter over
the next three quarters. This is marginally below its potential pace of 2.8
percent. The report can be found at www.td.com/economics.
South of the border, however, the U.S. economy will fall short of its
potential pace (3.3 percent) by a full percentage point, resulting in a
greater degree of economic slack. Moreover the American slowdown has only
reached its halfway mark.
U.S. Slowdown - Not All Doom and Gloom
An ever-deepening housing correction is scarring the economic landscape.
A sharp backslide in residential investment shaved 1 percentage point off real
GDP growth in the third quarter, which marked the largest drag from this
sector in 16 years. TD Economics expects to see a repeat performance in the
final quarter of this year given that housing starts plummeted 13 percent in
October.
Moreover American shoppers are already contributing about half a
percentage point less to GDP growth. And, estimates show that it takes at
least one year for the full impact of a change in real estate wealth to feed
through to consumption behaviour.
Still, not all is doom and gloom. “The precipitous decline in housing
starts is a necessary evil to shrink the inventory of unsold homes and return
the market back to balance,” said Drummond who went on to note that
residential investment as a whole accounts for only 5 percent of the total
economy and it alone does not have the power to cause consumer spending to
retreat.
Furthermore, there are no instances when a recession took hold that did
not correspond to mass job losses. The labour market backdrop is standing on
firm ground this time around. And, the current level of real interest rates is
still 2 percentage points below that seen heading into prior recessions.
Weak Demand for Canadian Exports A Dominant Theme in 2007
The slowing of U.S. demand, along with high resource costs and an
elevated Canadian dollar, will continue to hurt Canadian exports. Drummond,
who believes the weak export sector will be a dominant theme over the next 6
to 9 months, stated: “The challenges of the export sector are plain to see on
manufacturing, which has shed more than 170,000 jobs in the past two years.
Exports will be hard-pressed to expand at even a meager 1 percent rate in
2007. Meanwhile, import growth should remain reasonably firm underpinned by
domestic demand. As such the trade balance is will likely shave 1.3 percentage
points from the accounting of real GDP growth next year.”
Canadian Household Finances On Solid Footing
Canadian consumers should be less affected by developments in domestic
housing markets, which were never bloated to the extent of their American
counterparts. Likewise, the Canadian economy has not been confronted with a
severe adjustment in home construction, inventories, sales or prices, as has
been the case in the U.S.
Even in cooling housing markets, such as those in central Canada, price
gains remain in the 3 to 5 percent range. Home price growth is expected to
remain in the black across the nation in 2007. Meanwhile, residential
construction is only marginally lower today than it was at the start of the
year. Any drag from cooling housing construction will be mild in comparison to
the U.S.
This is not to say that the Canadian economy is free of housing risks.
For instance, residents in Vancouver dedicate an inordinate amount of pre-tax
income (+50%) to housing costs, while Alberta’s double-digit price growth
won’t be sustained. However, a boom-bust cycle can be avoided if price growth
cools in the near-term, which seems quite possible given ongoing supportive
fundamentals. Some hopeful signs for a potential soft landing have already
emerged. New listings are up substantially in Calgary (51% y/y), Edmonton
(27% y/y) and Vancouver (19% y/y), which should help alleviate price pressures
in time. If a hard landing were to befall the western provinces, it would
likely be due to the ripple effect of an unexpected collapse in the U.S.
economy, rather than a sharp reversal of domestic fundamentals.
Household finances also look healthy enough to withstand the expected
moderation in economic growth, especially if gauged by 90-day mortgage
delinquency rates, which currently remain at a more than 15-year low.
Mortgages account for nearly 61 percent of total household liabilities. And,
the asset side of the ledger sheet has increased at a faster rate than debt,
such that net personal wealth (assets minus liabilities) has climbed steadily.
“As expected, growth in real estate assets has played a key role in
wealth accumulation, representing more than one-third of total household
assets and growing at a 7-9 percent annual clip since 2001,” said Drummond.
“The cooling housing market will take some zip off of real estate appreciation
in the coming year, but the absence of a market collapse should position real
estate assets to still rise by a 6-7% clip in 2007, which is consistent with
historical norms.”
Within this milieu, the Bank of Canada will likely ease rates by 50 basis
points in 2007, with the first of two cuts coming in April. This should be
viewed as a precautionary move on the part of the central bank. By the second
half of 2007 and into 2008, a revitalized American economy should help lift
the Canadian economy back to an average 3.2% quarterly pace in late 2007
through 2008.