CANADA. Canada. Export-related industries are outperforming. Non-residential investment is falling

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1 CANADA Economic growth is projected to strengthen in 216 and reach 2.2% in 217. As the contraction in the resource sector slows, activity in the rest of the economy is projected to gain traction. Non-energy exports should continue to benefit from the earlier depreciation and strengthening export market growth. Consumer price inflation is projected to rise to around 2% as the effect of falling gasoline prices fades and excess capacity is gradually eliminated. The moderately expansionary policy stance in the 216 federal budget will help the economy return to full employment. In the medium term however, in light of provinces unfavourable debt dynamics, the government should adopt ambitious medium-term debt and budget balance objectives to ensure that general government debt remains sustainable. Gradual increases in policy interest rates are assumed from late 216 to stabilise inflation at around 2%. Macro-prudential measures should be tightened further and targeted regionally to reduce financial-stability risks from high household debt and house prices. Reducing barriers to foreign direct investment in telecommunications and broadcasting and air transportation would boost productivity and reduce qualityadjusted prices. Such measures would also disproportionately benefit lower- and middle-income households. Boosting inter-provincial competition by liberalising electricity generation and distribution and reducing barriers to internal trade would have similar effects. Replacing the tax preference for small companies by targeted measures for small businesses having difficulty obtaining finance would also boost productivity. Canada Export-related industries are outperforming Non-residential investment is falling January 213 = 1¹ 11 Export-related industries² Commodity-prices-sensitive industries² 18 Rest of the economy² Mining investment³ Other business investment Y-o-y % changes Three-month moving average of real output. 2. For more details on the composition of the industries and their weight on GDP, see note in Chart 9 of Bank of Canada (216). 3. Includes oil and gas. Also includes some engineering structures investment that may relate to other sectors. Source: Bank of Canada (216), Monetary Policy Report, April, Chart 9; Statistics Canada, Tables and 38-68; OECD Economic Outlook 99 database

2 Canada: Employment, income and inflation The economy is recovering Looking through quarterly volatility, real GDP is expanding at an annual rate of around 2%. Growth in non-commodity export-related industries has picked up to still higher rates, aided by the earlier fall in the Canadian dollar and the recovery in export markets, but industries most affected by commodity prices remain depressed. Business investment in the oil and gas sector continues to fall sharply it is likely to be about 6% below its 214 level in but should be a smaller drag on growth thereafter. Other business investment is also weak but should pick up as capacity utilisation in many non-commodity exporting sectors is already high and credit conditions are easing. Growth in private Canada % of labour force Labour market pressures are declining Unemployment rate¹ Labour shortage intensity² % balance Falling gasoline prices have reduced inflation Y-o-y % changes Headline inflation Inflation excluding gasoline Twelve-month moving average. 2. Percentage of firms reporting more intense labour shortages minus the percentage reporting less intense shortages. Source: Statistics Canada, Tables 282-1, and 326-2; Bank of Canada (216), Business Outlook Survey - Results of the Spring 216 Survey, April

3 Canada: Financial indicators consumption has been subdued, reflecting adjustment to the terms of trade losses since mid-214 (amounting to about 3% of national income), but should get a boost from the new Canada Child Benefit. At the national level, housing starts are running at the higher end of demographic requirements and housing investment is robust, especially in British Columbia and Ontario, although it is declining in oil-producing provinces. The recent fires in Alberta have shut down some oil-sands production, depressing economic growth in the Canada: Demand and output

4 Canada: External indicators second quarter of 216, but activity is likely to bounce back in the third quarter as production resumes. Despite steady employment growth, the unemployment rate has remained slightly over 7% since late 214. High involuntary part-time employment and long-term unemployment, as well as weak wage pressures, point to continued labour market slack. Consumer price inflation has fallen to the lower end of the Bank of Canada s 1-3% target range despite the exchange rate depreciation, but this reflects falling gasoline prices excluding these, inflation is near 2%. Macroeconomic policies are expansionary Fiscal stimulus in the recent budget could boost GDP growth by around.5% in both 216 and 217. The general government deficit is projected to rise by.5% of GDP over , to 2.2% of GDP. This increase mainly reflects 216 federal budget measures to boost demand, notably infrastructure spending, which is a government priority. The new policy package also includes measures to redistribute income towards low- and middle-income families. The most important of these is the replacement of existing programmes to help families with children, some of which are not means tested, by the means-tested Canada Child Benefit. There is also a substantial increase in funding to improve conditions for Aboriginal peoples. The central bank held its policy rate unchanged at.5% at its April meeting, despite upward pressure on the dollar. Based on the Bank s projection that economic slack will be taken up by the second half of 217, the projection assumes that monetary stimulus will be gradually withdrawn starting in late 216. Very low borrowing rates have encouraged household credit growth and underpinned rapidly rising housing prices, particularly in Vancouver and Toronto, which together are a third of the Canadian housing market. In relation to household incomes, both house prices and household debt are high. Macroprudential measures have been strengthened recently but should be tightened further and targeted regionally. 12

5 A number of policies could raise productivity and reduce income inequality. In telecoms and broadcasting and air transportation, easing restrictive foreign ownership rules would sharpen competitive pressures, raise productivity and reduce prices for consumers. In the electricity sector, developing more east-west connections where economic and allowing competition in generation and retail distribution would also lower prices. In inter-provincial trade, to reduce non-tariff barriers, which raise costs and prices, coverage of the Agreement on Internal Trade should be broadened and provincial authorities should reconcile regulatory differences, in some cases by recognising each other s regulations. Growth in non-energy exports and investment should lead the recovery Economic growth is projected to strengthen in 216 and reach 2.2% in 217. The drag from falling investment and employment in the resource sector should soon peak and then gradually fade away. Non-energy exports should lead the recovery as they continue to benefit from the lower Canadian dollar and strengthening export market growth. Business investment outside the resource sector should rise with a lag as sectoral capacity constraints become binding. Growth in housing investment, on the other hand, should weaken, as further supply comes onto the market and the boost from past interest rate cuts fades. With moderate growth in household incomes, private consumption should continue to grow steadily. The unemployment rate is projected to edge down to 6¾ per cent by late 217, and, with gasoline prices and the exchange rate stable and excess capacity eliminated, the inflation rate could rise to around 2%, the midpoint of the Bank of Canada s target range. The greatest risk surrounding these projections is global oil prices. If they were to be higher than assumed, this would limit cuts in energy-sector investment and employment, while further falls in prices would accentuate these cuts. Developments in emerging market economies, notably China, will have an important bearing on commodity prices and export demand. The main domestic downside risk is a disorderly housing market correction, particularly in the high-price Toronto and Vancouver markets. This would damp residential investment and private consumption, and could threaten financial stability. In addition, the rotation of economic activity from commodity-producing sectors to other sectors could be more protracted than expected. The main upside risk is that the US economic expansion could be stronger than projected, lifting demand for Canadian exports. 13