Canadian economic growth seen as sluggish despite fiscal stimulus

Subdued energy prices, soft U.S. demand dampen boost

(Reuters) - A quarter of analysts polled by Reuters pared back Canadian economic growth forecasts for this year and next compared with three months ago, saying subdued energy prices and soft U.S. demand will dampen the boost from expected fiscal stimulus.

The Bank of Canada is therefore likely to keep interest rates at low levels for even longer than thought to support the economy, with analysts pushing out their expectations for a rate hike to the second quarter of 2018.

Hurt by a drop in exports and a disruption in oil production caused by wildfires in Alberta, the economy shrank in the second quarter at the steepest rate since the global financial crisis.

Although the economy is expected to have recouped robustly in the third quarter, analysts in the poll of over 40 respondents said the strong pace of its rebound will not carry through to the remainder of the year.

The price of oil, a key Canadian export, is still down over 50 per cent from its mid-2014 high of $116 a barrel, while demand for the country's other exports remains tepid due to weak U.S. intake.

Bank of Canada governor Stephen Poloz has pinned hopes on a non-energy export-led rebound in Canada, thinking that a combination of a weaker currency and stronger U.S. demand would make a potent mix.

Although the U.S. economy seems on a stronger footing now, uncertainty around the upcoming presidential election and the timing of the next Federal Reserve rate hike could continue to weigh on demand for Canadian exports, despite a weak domestic currency.

The poll forecast Canadian economic growth at 1.2 per cent this year, short of the bank's 1.3 per cent estimate, and at two per cent in 2017, versus the bank's 2.2 percent prediction and July poll's median consensus of 2.1 per cent.

"The energy sector is still suffering and I don't see light at the end of the tunnel anytime soon, even if commodity prices seem to be slowly creeping higher again," said Thomas Costerg, senior economist at Standard Chartered Bank.

"There is some optimism around the U.S. economy but ... you see signs the U.S. economy is not performing as well as it should. There is still a big question mark."

 

LUKEWARM FISCAL IMPACT

To lend support to the Canadian economy, the Liberal government in March projected a $29.4-billion budget deficit for this fiscal year as it spends on infrastructure and benefits for families and the middle class.

However, economists in the poll were wary of how much that would help in boosting economic growth.

"Fiscal stimulus is a positive for growth, but it is a modest positive. It is just a patchwork solution in the meantime," said Emanuella Enenajor, North America economist at Bank of America-Merrill Lynch.

Only three out of 19 analysts who answered an extra question in the poll said the current fiscal stimulus would be effective. Thirteen said it would be only somewhat effective, while the rest said it would not be effective at all.

Canada's central bank cut rates twice last year, bringing them to 0.50 per cent, to dull the sting of the oil price crash. The economy fell into a brief recession, nonetheless.

But lower rates prompted Canadians to take on even more mortgage debt. The household debt-to-income ratio hit a record high 167.6 per cent in the second quarter, stoking fears of a correction in the housing market.

Canada's economy is increasingly driven by housing, which is a key risk going into 2017, said Standard Chartered's Costerg. He added that the recent regulations to curb house price inflation also pose a downside risk to economic growth.

House prices, especially in urban centers Toronto and Vancouver, continue to scale new heights despite a brittle economic outlook. In contrast, the pace of construction of new houses is expected to slow over the coming year.

But with overall inflation remaining below the BoC's two per cent target, and the economy still weak, a small minority of economists said the central bank's next move will more likely be a rate cut than a hike. Three forecast a trim this quarter.

Latest stories