Canada: Country outlook
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COUNTRY VIEW - FROM THE ECONOMIST INTELLIGENCE UNIT
OUTLOOK FOR 2008-09
The next general election, whether early or as scheduled in 2009, is likely to produce another victory for the Conservatives, although again without a majority.
The Bank of Canada (BOC, the central bank) will hold interest rates at 3% until the second half of 2009 when the economy and inflationary pressure begin to strengthen. But a more abrupt weakening than forecast by the Economist Intelligence Unit could require more cuts.
We have lowered our forecast for growth in 2009, to 0.9% (from 1.4%). This revision largely reflects our more cautious view of private consumption prospects in the light of our downgrading of the outlook for the US economy.
The average annual rate of inflation is forecast at 3% in 2008. This overshoots the mid-point of the BOC’s target range, but the rate should slow to 2.3% in 2009 as the world economy slows and commodity prices recede.
The current-account balance is likely to move into deficit in 2009 for the first time since 1998. This will follow a small surplus in 2008.
Export volumes will continue to be depressed by the strength of the Canadian dollar. There will be no respite for Canadian exporters while the currency remains near parity with the US dollar.
DOMESTIC POLITICS: The Conservative Party has been in government since its election victory in early 2006, but it does not hold a majority in the House of Commons (the lower house of parliament and main legislative body). This means that legislative progress depends on an alliance with at least one of the opposition parties, and has limited the Conservatives’ ability to implement their policy agenda. The administration’s mandate could extend to October 2009, when the next general election is scheduled. But the Conservatives’ lack of a majority has increased the possibility of an earlier election, which could be called if the government is defeated in a parliamentary vote.
INTERNATIONAL RELATIONS: With parliament recessed for the summer, the prime minister, Stephen Harper, has turned his attention to international politics. His recent trip to the G8 summit in Japan and its particular focus on climate change improved his environmental credentials, which were challenged recently by the Canadian opposition’s new policies, and it is likely that this will be a strong element of Canada’s foreign policy in the future. Earlier in his term Mr Harper also worked to improve US relations, but has trodden more carefully, as the current US administration is very unpopular in Canada. Canada’s trade relations with the US have recently faced a number of obstacles. These have included a Canadian complaint to the World Trade Organisation (WTO) about US farm subsidies and the Canadian rejection of a takeover bid for a Canadian high-tech company by a US weapons manufacturer. In addition, rising protectionism in the US and difficulties experienced by Canadian exporters as a result of tightened US border security continue to be potential points of conflict.
POLICY TRENDS: Lacking a parliamentary majority, the government will be unable to push through major changes in economic policy. Environmental policy has become more important, particularly with the Liberals’ new carbon tax proposals and growing support for the Green Party (although as yet unrepresented in parliament), and environmental issues will move up the political agenda, although they will have to compete with the demands of a weakening economy. Discussions have also started on improving financial services regulation, which is currently administered at the provincial level, and a new inter-provincial agreement on recognition of worker qualifications, signed in July, will help to integrate provincial labour markets.
INTERNATIONAL ASSUMPTIONS: We have downgraded our growth forecast for the US, the euro zone and Japan in 2009–as such, the OECD is expected to grow by just over 1% next year, following an expected 1.7% this year and nearly 3% in 2007. In the US, growth will be constrained by severe weakness in private consumption on the back of the continued adjustment in the housing and financial sectors. In addition to the fallout from the global credit crunch, domestic demand in the euro zone is also being hit by a run-up in inflation, which is undercutting real incomes. Exports, meanwhile, are being squeezed by the high euro. The slowdown in 2009 in the US in particular will hit Canadian exporters hard. We have also revised downward our forecast for oil prices in 2009–we now expect dated Brent to average US$110/barrel in 2008 and US$91/b in 2009 (from US$120/b and US110/b respectively) to reflect the sharp slowdown in developed-country demand for the resource.
ECONOMIC GROWTH: The Canadian economy has posted healthy growth in recent years, at an annual average of 2.9% in 2006-07, but growth slowed sharply in the fourth quarter of 2007 and contracted in the first quarter of 2008. We forecast that the economy will remain weak throughout the remainder of 2008, driven by the downturn in the US and the strength of the Canadian dollar and, as a consequence, falling Canadian export volumes. Growth is thus likely to average around 1% for the year. The US decline will continue and worsen in 2009 as the effect of the recent financial sector troubles persist. Following our downgrading of the US forecast, we have also lowered our forecast for Canadian growth in 2009, to 0.9%, down from 1.4% previously. This revision largely reflects our more cautious view of private consumption prospects.
INFLATION: Headline consumer price inflation accelerated sharply in June to 3.1% year on year, from 2.2% in May. This was driven by accelerating fuel costs, which rose by 26.9% in June on the year-earlier period, the fastest rate since September 2005, when major hurricanes caused turmoil in the oil market. Underlying inflation–the consumer price index excluding the eight most volatile items and changes in value-added taxes–held steady at 1.5%, unchanged since April, illustrating the importance of oil and oil-related costs on headline inflation. Underlying inflationary pressures have been dampened by the strength of the Canadian dollar, which has exposed local retailers to strong price competition from across the border in the US. However, this effect diminished in the first six months of 2008, as the currency’s value against the US dollar remained largely unchanged and the price of dated Brent Blend crude increased by one-half. But we expect oil prices to fall back overall in the second half of this year, and thus forecast that the annual average rate of inflation will rise by 3% in 2008 as a whole–this is a slight increase from our previous report and reflects our view that inflation will peak in the current quarter before easing subsequently. This overshoots the 2% mid-point of the central bank’s 1-2% target range, but the rate should slow to 2.3% in 2009 as the world economy slows and commodity prices recede.
EXCHANGE RATES: Strong commodity price growth and US interest rate cuts pushed the Canadian dollar to record highs against the US dollar in 2007, and the currency weakened only marginally in the first few months of 2008, averaging just over parity in the year to July. Continued high commodity prices will boost the value of Canadian exports, helping to offset any reduction in demand from the weakening US economy, and reinforce the Canadian dollar’s value. The Bank of Canada’s cycle of monetary loosening and interest rate cuts ended in June, in anticipation of continued global inflationary pressure, and the Canada-US interest differential is likely to remain steady, with further US interest rate cuts currently not factored into our main scenario. As a result, we expect the Canadian dollar to appreciate from an average of C$1.07:US$1 in 2007 to C$1.04:US$1 in 2008, and to weaken only slightly in 2009, to C$1.09:US$1, as oil prices recede further.
EXTERNAL SECTOR : The current-account balance is likely to move into deficit in 2009 for the first time since 1998. This will follow a small expected surplus in 2008. Export volumes will continue to be depressed by the strength of the Canadian dollar, which appreciated by 37.4% in real trade-weighted terms between 2002 and 2007, and there will be no respite for Canadian exporters in 2008 while the currency remains near parity with the US dollar. The slowdown in the US economy, which will deepen in 2009, will take a heavy toll, as the US is Canada’s main export mark
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