Canada faces long-term pain from economic shift, Poloz says

Theglobeandmail.com
Jan. 7, 2016
By Barrie McKenna

Bank of Canada Governor Stephen Poloz says Canada is facing a long and painful fallout from a “seismic shift” in global resource prices that could last up to five years and drain $50-billion a year from the economy.

Canadians will have to live with a cheaper dollar, higher-priced imported goods, and bumpy growth across the country.
.
“That undercurrent will last for several years,” Mr. Poloz told reporters after delivering a speech in Ottawa. “It typically takes three or five years to adjust to a significant shift in your terms of trade, which is what we’re going through.”

“Terms of trade” is the ratio between the prices a country gets for its exports and what it pays for imports.

Nonetheless, Mr. Poloz insisted that the Canadian dollar, which has plunged to near 70 cents (U.S.), is helping to offset the billions in lost revenue from exports of oil and other commodities. The drop makes Canada’s non-resource exports more competitive in world markets. A lower dollar is generally beneficial to exporters because they pay for their inputs, such as labour, in Canadian dollars, while their sales are generated in the higher U.S. dollar.

“Movements in exchange rates are helping economies, including ours, make the adjustments that must take place,” Mr. Poloz said in his speech. “This is exactly why countries choose to have flexible exchange rates.”

Mr. Poloz’s comments coincide with a global stock sell-off triggered by renewed concerns about a slowdown in China, the world’s No. 2 economy after the United States. The Standard & Poor’s/TSX composite index lost more ground on Thursday and is now down about 20 per cent from its 2014 high - the conventional measure of a bear market. The Dow fell 2.32 per cent, or 392.1 points, while the Nasdaq composite dropped 3.03 per cent, or 146.3 points.

Canada’s economy is directly affected by what is happening in China, where a weaker appetite for resources is depressing prices for oil, coal, copper and many of the key commodities that dominate this country’s exports and investments.

Mr. Poloz said the cost to the country’s $2-trillion (Canadian) economy inflicted by lower commodity prices and higher import prices is $50-billion a year or $1,500 per person. Mr. Poloz also said he is fully prepared to live with a bit more inflation, which he insisted is temporary.

Mr. Poloz also played down the implications for Canada of the recent turmoil in Chinese financial markets, and dismissed fears that some other countries will devalue their currencies to reap the advantages.

“It’s not a war. It’s a process,” he told reporters.

Mr. Poloz’s endorsement of the benefits of the weaker Canadian dollar comes as the U.S. Federal Reserve has begun to push up its key short-term interest rate. This makes Canada a less attractive place to invest, putting additional downward pressure on the loonie, now down more than 30 per cent from its 2011 peak of more than $1 (U.S.).

In his speech, Mr. Poloz highlighted a divergence in monetary policy around the world as a “natural” reaction to the commodities price shock. He added that, if necessary, the Bank of Canada could use unconventional tools - such as negative interest rates and large-scale bond purchases - even as the Fed moves in the opposite direction by hiking its benchmark interest rate.

“The message he’s trying to get out is that, sure, the Canadian dollar has weakened a lot, but he’s okay with that,” said Ben Homsy, a fixed-income analyst at Leith Wheeler Investment Counsel Ltd. in Vancouver. “He was almost giving a green light to … some moderate further weakness in the currency.”

The downside of the cheaper dollar is that it makes a wide range of imports pricier, spreading the pain of the oil price shock from the oil patch to the rest of the country, Mr. Poloz pointed out in his speech.

The Bank of Canada does not seem inclined to raise interest rates to quell those inflation pressures. Mr. Poloz said that could cause even more damage to the economy.

His comments left economists unsure if the Bank of Canada will cut its key interest rate again at its next rate-setting announcement, which is on Jan. 20.

“[Mr. Poloz] didn’t signal an imminent rate cut, but didn’t rule one out either,” Bank of Montreal economist Benjamin Reitzes said in a research note. He pointed out that the central bank, which cut rates twice last year, could cut again if the price of oil falls further or economic conditions worsen.

Royal Bank of Canada deputy chief economist Dawn Desjardins said Mr. Poloz is in “wait and see” mode as he gauges whether the economic rebound in the latter half of 2015 continues this year.

Mr. Poloz acknowledged that a cheaper currency is not a panacea, and that it could take some time for non-energy exporters to feel the full benefits. He said governments may also need to use fiscal policy and more flexible labour regimes to bolster the positive effects of the weak dollar.