Downgraded economic forecast bad news for Liberals

Theglobeandmail.com
Oct. 22, 2015
By Bill Curry

Only two days after his dramatic election victory, Justin Trudeau has learned that the economy is not going to grow as much as he had expected over the next couple of years, which could put pressure on his economic agenda.

And while Mr. Trudeau’s commitment to spend billions on infrastructure should have a positive impact on growth, Bank of Canada Governor Stephen Poloz said it was difficult to determine how long it would take for the money to work its way through the economy.

“You can’t just assume the answer,” Mr. Poloz told reporters in Ottawa. “An infrastructure project, if it’s a [public, private partnership], it takes time to structure it. ... It takes time to get it organized and mandated and it takes time to get the holes dug and so on. So all of that means that how the money impacts the economy can be more gradual than the simple shock that an economist sticks in their model.”

Private-sector economists, such as Sherry Cooper of Dominion Lending Centres, estimate that economic measures proposed by the incoming government could boost growth by as much as 0.5 per cent over the next two years.

The Liberal election platform is based on the Bank of Canada’s July economic growth forecasts, but the central bank released an update Tuesday that downgraded its outlook for 2016 and 2017.

Mr. Trudeau won a majority government Monday after pledging to jump-start the economy by cutting taxes for the middle class and running three years of deficits to fund new infrastructure spending, before balancing the books in the fourth year of a mandate - putting him at odds with the economic prescriptions of his Conservative and NDP rivals.

In its quarterly Monetary Policy Report, the Bank of Canada says the Canadian economy is expected to grow by 1.1 per cent in 2015, which is unchanged from its July forecast but is nearly half of the 2-per-cent growth assumed in the federal government’s April budget.

In addition, the bank expects gross domestic product growth of 2 per cent in 2016, down from its July forecast of 2.3 per cent. The budget had assumed 2.2-per-cent growth. The bank now expects the economy will grow by 2.5 per cent in 2017, a slight downward revision from its 2.6 per cent forecast in July. The budget assumed 2.3-per-cent growth that year. As a rough comparison, Finance Canada has said a 1-per-cent reduction in GDP would reduce federal revenue by at least $4-billion.

The lower-than-expected growth could be offset if the Liberal government succeeds in launching its infrastructure program quickly, but many questions remain as to how such a plan would work and how much time it would take to launch the transit, social housing and other construction projects promised during the campaign.

The report did not attempt to estimate the fiscal impact of Liberal campaign promises. Mr. Poloz said the bank might be able to incorporate new government spending into its next quarterly report in January, but that will depend on what has been announced between now and then.

“We’ll have to just wait and see,” he said. “I just don’t know how fast things are going to move.”

Tuesday’s news will increase expectations for a new Liberal finance minister to release a fall economic update given that the Bank of Canada’s numbers and private-sector forecasts show much has changed since the Conservative government released its budget in April.

A common political cliche is for a new government to bemoan the fiscal mess left behind by the outgoing government. It remains to be seen what the Liberals will say about what they’ve learned from officials. They likely won’t get a peek at the federal books until after a new cabinet is sworn in on Nov. 4.

Liberal MP John McCallum, who worked on the party’s fiscal projections, said Tuesday’s report shows the party was right not to rely on the April budget as a guide. The Liberal platform did not book revenue from additional economic growth created by tax cuts and infrastructure spending.

“I think it underlines the point that we were right to do what we did,” he said. “It makes even more sense to accept moderate deficits for three years and to invest now because that will help to mitigate the economic slump.”

Mr. McCallum said the party promised that the tax cut on income earned between $45,000 and $90,000 - coupled with a tax hike on any income above $200,000 - would be enacted quickly.

“We know that when people get the tax cut, they will spend a significant amount and that will help to create jobs and activity and therefore tax revenues, and similar for the infrastructure [spending],” he said. “Obviously, the lower growth will be a negative for the budget and the investments we make and our tax cut will be a positive, but I can’t tell you whether one is greater than, or less than, the other.”

Toronto Dominion Bank economist Brian DePratto said the Bank of Canada’s lower forecast would mean about $2.5-billion to $3-billion less in projected government revenue for next year.

He roughly estimated that infrastructure spending would have more of an influence on growth in 2017 than it would in 2016.

Mr. DePratto said he has not yet assessed the possible economic impact of other Liberal promises, including expanding the Canada Pension Plan and cutting Employment Insurance premiums in 2017, but not by as much as the Conservatives had planned.

“I would imagine every single [economics] shop in the country right now, they’re all doing the same thing. Getting the models going and then running through different scenarios,” he said.

Canada’s largest trading partner is “in a solid expansion,” according to the Bank of Canada, and will experience 2.5-per-cent growth this year - compared with the 1.1-per-cent growth expected in Canada. Americans are buying new vehicles at record levels and job gains have averaged 200,000 a month this year, lowering the unemployment rate.

The Chinese economy, which was built on exports, is shifting to one that is more focused on consumer spending. Growth in China will average just more than 6 per cent in 2016 and 2017, but that’s slower than in recent years. The bank now expects housing construction in China will be “more subdued” than it had anticipated in July.

Last year’s oil-price drop led to this year’s sluggish growth in Canada. Lately, prices have fallen further.

Average oil prices for West Texas intermediate have recently averaged about $45 (U.S.) a barrel, down from $60 in July.

The return of Iranian oil production could keep prices low. On the other hand, the bank notes there are signs that many U.S. oil producers are struggling and could scale back production, which would increase prices.

The Bank of Canada’s interest-rate policy aims to keep inflation, as measured by the consumer price index, within the range of 1 per cent to 3 per cent. The bank said Tuesday that total CPI inflation is expected to stay in the lower half of that range until 2017. The cost of imported goods is on the rise due to the depreciating Canadian dollar, but low gas prices have acted to keep inflation low.

After contracting in the first half of the year, the Canadian economy is now set to rebound. The lower value of the Canadian dollar and the bank’s two interest-rate cuts this year are expected to boost growth. The central bank lowered its overnight rate to 0.50 per cent in July, a move that followed a quarter-percentage-point cut in January.

Even with those actions, the bank still expects growth of just 1.1 per cent this year. It lowered its growth projections Tuesday for 2016 and 2017, forecasting growth of 2 per cent and 2.5 per cent, respectively.

The prospects for Canadian exporters depends on whether they are in the commodities business. Low oil prices continue to hurt Canada’s energy sector. However, the combination of a lower dollar and a strong U.S. economy is great news for non-commodity exporters. Building materials and metal products are among the export sectors that are enjoying “robust growth,” according to the bank.

The bank’s survey of Canadian businesses found that many manufacturers are expecting stronger sales thanks to the U.S. economy and the low dollar. That will mean more hiring and more spending on machinery and equipment. It is a much different story in the energy sector, where companies are cutting costs. Investment in the energy sector is expected to decline by about 20 per cent in 2016.

There is “trifurcation” in the Canadian housing market, according to the Bank of Canada. Essentially, Canada’s housing sector can be divided into three. The market is strong in British Columbia and Ontario, weak in Alberta and Saskatchewan and mostly soft in the rest of the country.

The bank expects prices and household indebtedness to stabilize as the economy improves.