“The U.S. consumer – a key source of world locomotion – will likely break stride as recent steep increases in oil, gasoline and natural gas prices bite into discretionary income. Domestic demand also should be tempered in Europe and Japan alongside a general shift in earnings and growth momentum from resource consumers to producers,” says Warren Jestin, Scotiabank’s Chief Economist.
U.S. reconstruction in the wake of Hurricanes Katrina and Rita, partially underwritten by a resurgence of Washington’s deficit to US$400 billion, will boost construction through 2006. Tough international competition also will keep businesses focused on investing to enhance productivity and cut costs. However, rising import dependence on a wide array of commodities, manufactured goods and services will act as an overall drag on growth. Add in a more cautious consumer – even with historically low mortgage rates and a new wave of once-in-a-lifetime auto discounts – and U.S. growth will probably slow by nearly half a percentage point over the next year from the 31/2%-plus trajectory evident in the first half of 2005.
“Canadian growth is already tracking more than half a percentage point below the U.S. pace. While not great, it is still a solid performance considering the drag on non-energy exports, particularly manufactured goods, imposed by increased foreign competition and a rising loonie,” says Jestin. “Canada will continue to lag the United States during 2006, with the resource- rich provinces leading the nation while net energy-consuming regions – particularly in Central Canada’s manufacturing heartland – are caught in the slow lane.”
The reasons are straightforward. Prices for energy and a number of industrial commodities, elevated by a mix of strong global demand and supply bottlenecks, are helping to tip growth westward. Canadian natural gas exports are running around $30 billion annually and our trade surplus in energy products is approaching $50 billion, more than double the level recorded in the late 1990s. Over the same period, our trade surplus in the Ontario-centred motor vehicle and parts industry has dropped by more than half and will fall below $10 billion in 2005 for the first time since 1997.
The challenges confronting Canadian exporters will be accentuated in the months ahead as offshore competition intensifies, particularly if the loonie continues to gain altitude and tests the 90 cent(US) threshold for the first time in a quarter century. The timing and magnitude of further appreciation is difficult to predict in a market prone to volatility and sudden spasms. However, the Canadian dollar is bound to gain greater status as a commodity- based currency as exploration and development escalates in the oil, gas and mining sectors.
“The strength in our exchange rate will also be fuelled by a longer-term tendency for the U.S. dollar to decline against other major currencies as investors diversify to contain already large exposures to the greenback. A growing import dependency on energy and consumer goods has pushed the U.S. trade deficit on oil and natural gas above US$250 billion and with Asia towards US$300 billion,” says Jestin. “This year’s current account deficit will exceed US$800 billion and may move higher in 2006 as the U.S. economy pulls in more imports and overseas markets in Europe and Japan remain subdued.”
On the interest rate front, the U.S. Federal Reserve and the Bank of Canada will continue nudging interest rates higher in the months ahead. However, the passthrough from sharply higher commodity prices to overall inflation will be limited by softening consumer demand and intense competitive pressures. In this environment, the upcoming rise in borrowing costs on both sides of the border should be less than a percentage point.
On a regional basis, energy-rich provinces are likely to lead the nation’s economic and fiscal performance over the balance of the decade. The average unemployment rate in B.C., Alberta and Saskatchewan has moved into the 5% range, 21/2 percentage points below the average for other provinces, with labour shortages and wage pressures emerging in key energy-related industries. The widening differential in personal and corporate income growth is adding to the fiscal lead enjoyed in Western Canada, allowing these provinces to undertake initiatives that are more difficult in the Central and Atlantic regions.
Ontario – at the epicentre of the widespread industrial restructuring triggered by increased global competition – also is confronted with the need to overhaul its power generation and network. Ontario’s ability to meet its pressing policy priorities is further hamstrung by the need to eliminate its deficit and by a convoluted system of federal-provincial fiscal arrangements that transfer large amounts of financial resources from the province to other parts of the country. From a fiscal perspective, growing regional imbalances may be pushing federal-provincial relations to a tipping point.
Machinery & equipment investment, strong consumer spending and infrastructure outlays are expected to maintain real GDP growth in Quebec of slightly over 2% through 2006. Several large-scale hydro generation projects are also providing significant economic support. While higher global prices are boosting the mining sector, some restructuring is expected in resource- related manufacturing such as pulp & paper. The stronger dollar and competition from low-cost overseas producers are squeezing other traditional manufacturers such as textiles.
Major construction projects, including Canada’s first liquefied natural gas plant, will underpin solid growth in New Brunswick through 2006. At the same time, this year’s anaemic pace of job growth is expected to dampen retail activity. Nova Scotia’s outlook is mixed. Offshore exploration activity has cooled and production from the Sable natural gas field through August is down 7% from last year’s levels. The Port of Halifax, however, is seeing increased activity diverted from congested Pacific Coast routes. PEI’s modest economic expansion will be sustained by several large construction projects and a strong food processing industry. Newfoundland & Labrador’s economy should rebound sharply in 2006 following a relatively lacklustre expansion this year, with provincial exports boosted by the start-up of the province’s third oil field, White Rose, and the Voisey’s Bay nickel project.
To view a recent webcast of Scotiabank’s Chief Economist, Warren Jestin, and ScotiaMcLeod’s Director of Equity Trading, Fred Ketchen, presenting the Global Outlook, visit www.scotiabank.com.
The Global Outlook and other Scotia Economics publications are available at www.scotiabank.com and on Bloomberg at SCOE.
Scotia Economics provides clients with in-depth research into the factors shaping the outlook for Canada and the global economy, including macroeconomic developments, currency and capital market trends, commodity and industry performance, as well as monetary, fiscal and public policy issues.
For further information
Warren Jestin, Chief Economist, Scotiabank, (416) 866-6136
Aron Gampel, Deputy Chief Economist, Scotiabank, (416) 866-6259
Jane Shannon, Public Affairs, Scotiabank, (416) 866-6806
Photo credit: Images by John ‘K’ via Visual Hunt / CC BY-NC-ND
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