What Canada’s hot streak means for interest rates

The Canadian economy is firing on all cylinders and growing faster than its potential, says the latest RBC Economic Outlook. The main drivers are consumer spending, business investment and government spending.

“That should see above-potential growth continue through the rest of this year,” the bank says in a release. RBC Economics expects real GDP to grow 3.1% in 2017 and 2.2% in 2018.

“Canada’s economy continues to hit it out of the park,” said Craig Wright, senior vice-president and chief economist at RBC. “For the fourth consecutive quarter, we’ve seen above-potential growth, and despite the cooling of the housing market and uncertainly around NAFTA, we expect the momentum to carry through to the end of the year.”

Read: Returns elude Canadian investors despite strong GDP

As well, the bank says consumers aren’t showing signs of slowing down and, as a result, they’re poised to remain the key driver of growth in 2017. While consumer spending will likely lessen somewhat in 2018, it adds, “business investment continues its significant turnaround. Investment spending is expected to add growth every in quarter this year, and will likely remain an important driver of the economy in 2018.”

Following this week’s Bank of Canada rate hike, RBC Economics expects the central bank to continue to reduce policy stimulus. In its outlook report, it says “the overnight rate is expected to finish 2018 at 2%, up from 1% today.”

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RBC isn’t alone in its optimism.

Jean-François Perrault, senior vice-president and chief economist for Scotiabank Global Economics, also calls for growth to surpass 3% in 2017 before slowing to about 2% in 2018, in a Friday report.

“Of particular note in Canada is the breadth of activity: most provinces are growing rapidly, in sharp contrast to previous years, and there is broad strength across many sectors of the economy,” he says.

As a result, Perrault predicts the BoC will “raise interest rates well beyond current levels.” A hike may occur in December, with two more following in 2018, he says. He notes that even though lower growth is in the cards for 2018, “it would remain well above estimates of potential growth, which implies greater inflationary pressures through the year. Additional rate increases will likely be required in 2019.”

In a separate Scotiabank report, head of Capital Markets Economics Derek Holt writes “the BoC is behind the curve with firming wage and price dynamics that are unique to Canada.” When it comes to employment data – on Friday, Statistics Canada said Canada’s unemployment rate nudged down in August – Holt suggests focusing on wage data in relation to the BoC.

Read: Canada posts ninth straight monthly job gain

He explains, “Average hourly wages for permanent workers is the measure the BoC focuses upon, and that accelerated to 1.7% y/y, which is up a half point from the prior month.”

Other highlights from RBC

The Canadian dollar rebounds. The Canadian dollar has risen 11% from its early May low. Also, the Bank of Canada’s rate hike solidified the dollar’s gains even in the face of declining oil prices. RBC forecasts the Canadian dollar will average close to 80 U.S. cents over the forecast horizon.

Read: Trade gap reveals potential for volatile loonie

Alberta back in the saddle and Quebec taking off. Most provincial economies have stepped up their pace relative to last year, but the country’s economic momentum is not shared equally across all provinces. A rebound in Alberta’s energy sector has led RBC to revise its forecast for the province upwards to 4.2% growth in 2017. At the same time, a major turnaround in Quebec will see the provincial economy growing 2.8% in 2017 – its strongest rate in 15 years. The outlook for Newfoundland and Labrador is less optimistic given its economic contraction continues. The provincial economy is expected to shrink 1% in 2017, says RBC.

Read: Why to watch the Ontario government, pre-election

Global growth versus geopolitical concerns. The global economy’s strong momentum over the summer has shifted some of the focus away from geopolitics, says RBC. Its forecast for global growth is 3.5% in 2017 and 3.6% in 2018.

Read: Expect political upheaval in emerging markets

U.S. optimism in the face of uncertainty. RBC is still optimistic about the U.S. economy. It projects growth of 2.2% in 2017 and 2.4% in 2018. The U.S. dollar has significantly underperformed other major currencies so far this year, the bank notes, but that may change as the U.S. Federal Reserve “likely to hike rates more than markets anticipate.”

Read the full RBC report and its separate provincial outlook report.

Also read:

U.S. growth in Q2 upgraded to 3%

How growing household debt levels are putting Canada at risk