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The End of Money for Nothing

Highlights

  • The global economy is expanding at its fastest pace since 2010, led by an ebullient U.S. economy. Global growth is projected to level off at 3.7% per annum in 2018 and 2019, reflecting some softness in recent trade and investment data and financial stresses impacting several emerging economies. Risks to the global outlook appear balanced.
  • The U.S., Mexico and Canada agreed to a revised trade pact on October 1. The agreement (the USMCA) sees Canada and Mexico allowing freer access to their markets in certain areas, in return for maintaining overall access to U.S. markets under somewhat less favourable terms than was the case with NAFTA. The new agreement should reduce uncertainty around trade and investment decisions in the short and medium term. However, unlike NAFTA, the pact is subject to review and renewal.  Companies considering major, irreversible investments in long-lived assets may not have the same certainty about future trading rules that they had under NAFTA.
  • The Canadian economy shows strong momentum and is running close to its potential. The composition of growth is expected to shift away from sectors that have feasted on unusually cheap and readily accessible credit since the late-2000s (i.e. consumption, new residential construction, renovations and real estate transfer costs). Export growth will be supported by strong U.S. demand, the resolution of trade access to U.S. markets, and the weak Canadian dollar. Business investment is also expected to play a larger role in the ongoing economic expansion as firms, especially in Central Canada and B.C., strive to meet demand amid widespread capacity constraints and labour shortages.
  • The B.C. economy has solid momentum. B.C.’s job market is one of the strongest in the country. The province has accounted for one-quarter of all new jobs in Canada over the past few years.  B.C. also has the highest job vacancy rate of any province and the unemployment rate is around 4%. 
  • B.C. is projected to grow in the range of 2.3% to 2.5% over 2018 and 2019, near the top of the provincial growth rankings. The changing composition of growth - toward investment and exports and away from credit-driven sectors – will likely be more pronounced in B.C.  The province’s role as a trade gateway and the contributions of the large transportation and logistics industry will continue to underpin its success. The recent announcement that LNG Canada is proceeding with its $40 billion LNG investment in Kitimat has prompted us to revise our provincial forecast up to 2.5% for 2019.  
  • The Canadian and B.C. economies are vulnerable to tightening financial conditions, however. The current leverage cycle that began in the second half of the 2000s is easily the largest of the post-war era.  Canada’s increase in private sector indebtedness has not been checked by any effective domestic policy response.  Monetary and credit supply policies have remained mostly accommodative since the 2008-09 recession to support economic expansion.
  • Global financial conditions are now clearly tightening. In September, the U.S. Federal Reserve raised its policy interest rate for the eighth time since 2015 and signalled that further rises are ahead.  Similarly, the Bank of Canada raised its policy rate to 1.75% in late October. Despite being the fifth increase since June 2017, Canada’s policy rate is still negative in inflation-adjusted terms – highly unusual at this point in the business cycle. Going forward, the Bank indicated it will need to raise rates to a neutral stance – which it estimates could be about 75 to 175 basis points higher – to keep inflation close to its target of 2% per annum.
  • The long era of cheap and easy credit appears to be over. As interest rates rise, Canada and B.C. could find that carrying current debt loads becomes much more challenging.

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