September 11, 2012


Title: Global risks cast pall

Subtitle: A strong economy means Canadians should be paying higher interest rates. But a slew of risks are keeping central bankers cautious. 


Canada’s most recent jobs report, which showed 34,300 net new posts created during August, provided yet another tangible sign of how different things are here than in much of the rest of the world.


“Canada’s labour market is in good shape,” notes Dawn Desjardins, assistant chief economist at RBC Economics. “Employment data have been volatile, however the economy generated almost 20,000 new jobs per month so far this year. Furthermore jobs created in 2012 have been full-time, with part-time employment up only marginally.”


While other major economies are stumbling, the land of the strong and the free is humming. Spurred by strong natural resource exports, Canada has recovered all jobs lost in the last recession (unlike the United States) with the unemployment rate here a respectable 7.3 percent. The housing sector, which is showing signs of weakening, is far stronger than those in most other OECD countries and stock markets too are rebounding, though on small volumes. The upshot is that the Canadian economy faces the prospect of being hit with central bank rate hikes sooner than pretty much anywhere else.


Canada stands alone….

“The Bank of Canada stands alone,” notes Craig Alexander, chief economist at TD Economics. “As long as the economic expansion continues, the next move in interest rates in Canada will be up.” Alexander’s observation makes sense. Although there is little evidence that overall inflation is getting out of hand, central bankers learned the hard way during the subprime loan crisis that if you pump too much money into the system, imbalances could pop up in unexpected areas, causing huge problems down the line.


Here in Canada, the prime candidates for imbalances caused by an extremely low central bank policy rate are the Toronto and Vancouver housing markets, and stocks, all of which are inflated far above where they would be at if rates were at normal levels. In addition, low market interest rates are forcing many seniors, who live on fixed incomes, to move portions of their retirement savings from the relative security of bonds, into far riskier equities, simply because they cannot afford to live on the less than 2.0 percent yields that ten-year Government of Canada bonds are currently paying.


As Benoit Durocher, of Desjardins notes, central bank authorities remain uncomfortable with the high degree of monetary easing currently in the system. And although the Bank of Canada kept its policy rate unchanged at 1 percent at its last meeting, it also reiterated its warning that that will not last forever.


Global risks

In fact the only reason that the Bank of Canada has not acted so far is that the global economy remains fraught with risks that could end up dragging Canada down along with it. Europe for one is in a recession and a financial crisis, with several euro zone states such as Greece, Portugal and possibly even Spain and Italy flirting with insolvency. And although the European central bank has pledged to take on parts of their debts to keep interest rates low, no one is sure if that will be enough.


The United States for its part is in the run-up to Presidential and Congressional elections, and few of its politicians are willing to own up the massive financial challenges the country faces. New debt ceiling negotiations scheduled for early next year and upcoming year-end “fiscal cliff” tax increases and spending cuts could tip Canada’s largest trading partner into recession too. 


China, another big Canadian export goods customer is also having problems. The country recently revised downwards its growth forecasts, and, as Matthieu Arseneau, of National Bank Financial notes, could suffer from a strong demand hit, as consumers there divert increased household dollars to fund rising food (notably grain) costs.


In fact, if you believe Moody’s Analytics, even Canada’s economy is not immune from possible tough times. The firm recently published a report which said that there is a 20 percent chance that Canadian consumer debt-income levels, which reached an all time high of 150 percent earlier this year, could send us into a downturn too.


RBC’s Desjardins for her part remains more optimistic. While she agrees that the main risks to Canada’s economic outlook come from outside its borders, she predicts stronger growth in the third quarter and that the Bank of Canada will maintain its policy rate low until the end of the year. Then next year, the central bank will start to reverse course as those global risks evaporate.


Of course whether those global risks do fade away remains one big “if.”






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