The end of government stimulus, the continued reluctance of U.S. consumers to spend and a softening of the Canadian housing market will see real GDP growth fall well below federal and provincial government forecasts for 2011, finds a new report from CIBC World Markets Inc.
“That softer growth outlook should not, however, lead to a rethinking about the need to begin to tighten the fiscal stance,” says Avery Shenfeld, chief economist at CIBC. “At this point, Canada is not the U.S. or Europe. If policy needs to adjust to a more challenging climate abroad, it should be done by backing away from plans for tightening through even higher interest rates. Only if the Bank of Canada were forced to take rates back to zero would it be appropriate to postpone a much-needed, if gradual, path back to fiscal rectitude.”
Mr. Shenfeld notes that Ottawa should have some $8 billion more revenue than forecast when the books are closed on 2010 which will help ease the pain of weaker than expected growth in the year ahead.
“The $27.6 billion 2011/12 deficit target might end up being a bit ambitious if revenue sources miss their targets in the face of weak growth. But containing spending looks appropriate, particularly if, as we expect, provinces have an even tougher time staying on course with their deficit reduction plans. It simply makes no sense to be stepping on the monetary policy brake while at the same time extending the timeframe for stimulus.”
The report finds that while all provinces saw a return to growth in 2010 and nine provinces are expected to exceed budget forecasts, 2011 paints a much bleaker picture. Growth in all provinces will be down, with the exception of Saskatchewan, which saw bad weather punish its agriculture sector this year. CIBC forecasts real GDP growth to fall nearly a full percentage point below budget forecasts in 2011, with central Canada’s manufacturing sector suffering the biggest hit.
“It was nice while it lasted, but provincial economies are now in the process of downshifting from a better-than-expected 2010 to a more tepid growth pace for 2011,” says Warren Lovely, government strategist at CIBC. “For job seekers, businesses and government budget makers, the implications will be significant.”
With the unprecedented fiscal stimulus and inventory rebuilding coming to an end in the U.S., CIBC forecasts Ontario will be hit the hardest given that it still sends some 80 per cent of its exports south of the border. It calls for the province’s real GDP growth to fall 1.6 per cent below the prior budget’s forecast in 2011. Québec and Manitoba, which also have large export-oriented factory sectors, will see growth fall well below expectations, coming up 1.1 per cent and 1.0 per cent shy of forecast, respectively.
Once again, the country’s resource-rich provinces, B.C, Alberta, Saskatchewan and Newfoundland and Labrador, will lead the country in growth, but they too will struggle to meet budget forecasts. Output from Alberta’s oil sands, where investment has more recently reignited, is set to climb steadily in the years ahead. There are some risks to navigate, however. U.S. environmental opposition has clouded the outlook for new pipeline development, while a shortage of upgrading capacity will limit the value added retained in the province and also leave it vulnerable to the differential in heavy and light crude prices.
With prices languishing, the outlook for conventional gas is muted, but B.C.’s vast shale gas deposits hold significant potential for the province going forward. Development of Saskatchewan’s oil industry is a meaningful driver, which alongside other resource sector investment (namely potash) is a tonic for above-average growth. As well, the transfer of technology to the conventional oil industry could be the key to recovering heretofore untouched reserves in mature fields throughout the West.
The resource-based provinces are not without their challenges. A labour market recovery has been incomplete in B.C. and Alberta, where the employment rate is holding materially below pre-recession peaks. Labour productivity has also tended to lag in the West. In part, that reflects the rapid development of the region’s resources that have yet to pay full dividends. In B.C.’s case, the implementation of an HST, while met with considerable opposition, has been designed to buoy investment and lay the foundation for productivity enhancements.
“The housing sector looks vulnerable in the West as well,” says Mr. Lovely. “Granted, no part of Canada looks to be immune to further housing market weakness, with significant momentum having been more recently lost. But it’s in B.C. and Alberta where housing prices have overshot fair market value by the largest margin, with an ongoing correction expected to dull residential construction activity and blunt consumer enthusiasm.”
While house prices are less-inflated in Québec and Atlantic Canada, demographics pose a serious challenge to long-term economic growth. Collectively, the Atlantic Provinces will see the size of the working age population fall in the coming five years, with official population projections from Statistics Canada showing the most severe decline in Newfoundland & Labrador. For the country as a whole, demographics are more constructive than most other advanced economies, with proven success attracting international immigrants a key driver of population growth, particularly in Manitoba and Ontario.
Absent any gains in the economically active population, Canada’s Atlantic Provinces will continue to be dependent on resource development and major capital projects to drive growth. That’s less of a concern in Newfoundland & Labrador, where resource production gains and large investments hold the key to future growth. In New Brunswick and Nova Scotia, the roster of major capital projects is relatively lean, setting the stage for below-average growth.
“In the end, the relatively sturdy economic backdrop provincial governments have hoped for won’t emerge, stalling progress on deficit reduction, adding to debt levels and eroding fiscal flexibility,” adds Mr. Lovely. “This is of particular concern in Ontario. A positive handoff from a stronger-than-expected 2010 will cushion only part of the blow. And barring corrective action, next year’s subdued growth prospects risk putting negative pressure on provincial credit ratings, and for fixed income investors, look to leave the sector once more on the defensive.”
The complete CIBC World Markets report is available at: http://research.cibcwm.com/economic_public/download/ssep10.pdf.
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For further information: please contact Avery Shenfeld, Chief Economist, CIBC World Markets Inc. at (416) 594-7356, [email protected]; or Kevin Dove, Communications and Public Affairs at 416-980-8835, [email protected]