Posted on July 12, 2012

Canada’s Growth Unexciting, But Fundamentals Strong

 For an economy very close to full capacity, this isn’t as bad as it sounds. The output gap in Canada is much smaller than in the U.S., having weathered the financial storm far better.

As we approach full employment next year, growth of much more than 2% could well trigger inflation warnings, and the Bank of Canada could begin to gradually re-normalize interest rates late next year. Employment growth had eased during the second half of the year before November’s strong report, and the jobless rate remains above 7%.

Consumers have geared down in the face of a heavy debt burden and slower job growth as well as the government’s actions to tighten mortgage conditions. In addition, the rise in credit card debt has slowed along with other forms of consumer credit. Auto-related debt is one exception as auto sales have been strong this year, and TransUnion’s quarterly survey suggested that car loans were growing at a double-digit pace in Q3. Consumer credit growth has fallen sharply this year to under 3% and is expected to remain modest during the next two years. Mortgage lending is moderating, albeit at slower pace than consumer credit. The housing market is cooling, with sales and price gains in most regions down from a year ago and prices actually slipping in the GTA, at least in the condo sector, and falling more noticeably in the formerly frothy Vancouver market.

For Canada as a whole, average home prices are little-changed since the start of the year. Our trade balance continues to deteriorate, reflecting the competitive pressures of a strong dollar as well as the drop in Canadian oil prices. Business investment has been leading the economic expansion, although outlays on equipment slowed during Q2 and Q3. Non-residential investment faced a setback in Q3, likely reflecting a slowdown in the oilsands. However, commercial construction is supported by low office and retail vacancy rates. Consequently, commercial credit growth remains solid and is supported by some switching from capital markets funding to intermediated loans. Reflecting the recovery in the Canadian economy since 2008, credit quality at the banks is the best it has been in four years. In comparison to the U.S. and Europe, Canada is in great shape.

Though the growth pace is not exciting, we remain a bastion of stability in comparison to many other developed and emerging economies. This is reflected in our strong currency, which has weakened our trade position thereby contributing to the slowdown in overall growth. But Canada remains a rock-solid triple-A country, at least at the federal level—our government functions smoothly (at least in comparison to our neighbour to the south) and the Bank of Canada is held in high regard. Canadian stocks have underperformed for the second year in a row, following seven years of sharp outperformance, largely due to the decline in energy stocks, technology (RIM) and an underperformance in the financial services sector, which had recovered more fully earlier in the cycle from a less depressed base than in most of the rest of the developed world.