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Bank of Canada will have to overcome the economic drag

Posted: May 8, 2013

The new governor of the Bank of Canada will have to overcome the economic drag from deteriorating trade, manufacturing, housing, consumption and government spending.

Stephen Poloz is inheriting an economy that has been losing momentum for months.

The good vibes that carried the Canadian economy out of the Great Recession are gone in the face of a host of new hurdles. Now, the country faces a troubled neighbour to the south, the end of a long commodities supercycle, a deflating housing bubble, much more cautious consumers, and governments unable or unwilling to make up the gap. And the Bank of Canada’s ability to influence events is severely constrained, since interest rates are already hovering near historic lows. “There are a number of major changes on the horizon and they’re all coming up negative for the Canadian economy,” pointed out Arthur Donner, a former Bank of Nova Scotia economist and monetary policy expert.

Trade, manufacturing, consumption, housing and government spending are potential drags on the economy, he said. And now commodity prices are slumping. “We are a commodities exporter, but the terms of trade have moved out of favour for Canada,” added Mr. Donner, now a consultant.

Perhaps most problematic, he suggested, is that Central Canada’s manufacturing economy is shrinking at the same time as the commodity-driven economy of Western Canada is also heading into a funk. It is “incredibly unusual” that both Alberta and Ontario are decelerating at the same time, according to Mr. Donner.

A big problem for Canada, which sells most of its exports in the United States, is increasing U.S. fiscal austerity, he said.

Mr. Donner added that the austerity is offsetting all the benefits of the monetary easing policies of the Federal Reserve, and is likely to keep the U.S. from gaining traction.

“It’s a tough economy for sure,” remarked National Bank of Canada senior economist Krishen Rangasamy.

With exports a mounting challenge, Mr. Poloz’s experience at Export Development Canada, where he has been president and chief executive officer since 2011, gives him a valuable perspective on the challenges faced by the country’s shrinking manufacturing sector, which has been saddled with a high dollar and intense overseas competition, Bay Street insiders say.

Mr. Poloz’s “understanding of Canada’s opportunities in the global economy will give him valuable insights in this new role,” Bank of Nova Scotia vice-chairman Sabi Marwah said.

Craig Wright, chief economist at Royal Bank of Canada, said that Mr. Poloz’s export background could come in handy as the bank tackles new problems in the future.

“We have heard more and more on exports,” Mr. Wright said.

As Canadian consumer spending moderates, economic growth will depend on demand from other countries, and even beyond the United States, Mr. Wright said.

The economy may grow at slightly better than 2 per cent in the first quarter, thanks in part to a surprise return to trade surpluses in March. But Mr. Rangasamy said that was driven by energy exports to the U.S. caused by an unusually long winter.

The first quarter may be a blip. Mr. Rangasamy said Canada’s gross domestic product is likely to grow just 1.5 per cent for the year – a second year that the country trails the U.S.

And next year looks only marginally better, at 2.2 per cent, according to National Bank’s forecast, substantially weaker than the 2.8 per cent pace forecast by the Bank of Canada.

Outgoing Bank of Canada governor Mark Carney has fretted for a year or more about the mounting debt burden of Canadians and the overheated housing market in parts of the country.

His successor inherits conditions that will be working in reverse. Housing prices are already falling in the most overheated markets, such as Vancouver, and housing construction is slowing.

At the same time, consumer credit growth is slowing. “That means more saving and less consumption,” Mr. Rangasamy said.

All that will make homeowners feel and act less confident in the months ahead.

And a slowing housing market will cost high-paying jobs.

Ottawa and most of the provinces aren’t cutting spending. But spending growth is flat. “they’re not cutting, but they’re not expanding as they have in past years,” Mr. Rangasamy said.

But there may be little the new Bank of Canada chief can do, given that interest rates are already extremely low.

As Adam Button, editor of ForexLive, put it in a blog Thursday: “Taking over the Bank of Canada at the moment is like a 747 captain handing the controls to his co-pilot on a trans-Atlantic flight. There’s nothing to do but hold the wheel and make sure it stays on course.”

Courtesy of The Globe and Mail