Dollar, gold seen moving higher in 2006

Economic forecasts for the coming year suggest global growth rates will be very similar to those posted in 2005, but outside of that high level prediction, opinions vary widely on a number of issues including interest rates, the price of oil, gold and the Canadian dollar.

Getting a consensus opinion from a group of economists is always a challenge, but most expect the U.S. Federal Reserve to raise interest rates to 4.5%. Some however, are calling for rate increases as high as 5%. Oil price predictions range from $57 to $72 a barrel. Those with lower oil estimates say price patterns will be different this year: where prices started out low in 2005 and climbed throughout the year, they say prices will start high in 2006 and gradually fall back.

CIBC World Markets economists say selling pressure against the U.S. dollar should help push the price of gold to $550 an ounce in the coming year. The possibility that OPEC and Russian reserve portfolios will reverse their current underweight in bullion, combined with the lack of any appealing dollar substitutes, is also adding to the metal’s lustre, according to Peter Buchanan and Leslie Preston.

The Canadian dollar is expected to reach 90 cents in 2006, which should help capital spending but also depress exporters who are already suffering from softening U.S. demand for imports and significant loss of market share to cheaper producers in Asia.

Jeff Rubin, chief economist at CIBC World Markets, writes that Canada’s surging energy trade surplus will keep the dollar well north of 80 cents during the year. “A 90-cent-plus currency will saddle Canadian manufacturers, half of whom are in Ontario, with 25% higher unit labour costs than their American competition.”

Overall, economists are calling for a moderation in consumer spending across North America, thanks to lower job creation numbers, higher borrowing costs, the waning housing boom and higher gasoline and home heating costs. Although some are more bearish on consumers, particularly in the U.S., others say capital spending will likely pick up the slack and make up for lower housing and household spending numbers in 2006.

At a recent Toronto Association for Business and Economics meeting in Toronto, Ted Carmichael, chief economist at JP Morgan Chase Canada, told business economists that over-focusing on the household sector in the first place is the main reason why so many analysts have been surprised on the upside by resilience in the U.S. economy in the past couple of quarters.

Although few say these are an actual concern at the moment, some risks to the economic outlook include the U.S. housing market, the possibility of boom bust cycles in China, “These would reverberate around the world, particularly in Canadian commodities,” says Carmichael; or a decision on the part of other global economies to stop accumulating U.S. dollars.

Bank of Montreal deputy chief economist Richard Egelton notes the possibility that both the Fed and the Bank of Canada raised interest rates too late in the game to be effective. If this is the case, he says the economy could spike after the Fed pauses in raising rates in the middle of next year. “There’s the risk that tightening came too late and too gradually and after a pause, the economy takes off. It forces the Fed to tighten to the point where rates bite.”

Going forward, Scotiabank chief economist Warren Jestin suggests that the Bank of Canada might outdo the Fed in precautionary tightening because of concerns that inflation will move higher in the face of the lowest national unemployment rates in a generation, mounting evidence of skilled labour shortages and rising capacity constraints.

Regional disparity is one of one of the biggest challenges the Bank of Canada is faced with in setting monetary policy. Alberta is on a tear, for example, but the province only makes up 15% of the country’s economy. As well, interest rate hikes are not effective in remedying the province’s labour shortage — there are only so many skilled workers mobile enough to relocate.

“Owing to notable differences in industrial composition, diverse regional responses to monetary policy serve to complicate Bank of Canada rate setting,” writes CIBC’s Warren Lovely. “Central Canada’s heavier weight in interest sensitive industry means monetary tightening is more forceful where it is now least needed. On the other hand, tightening is less effective in red-hot Alberta where risks of labour and materials shortages are most pronounced.”

Similarly, the outlook for Canada is mixed, depending on the province in question, and those regional differences are likely to endure.

Rubin says the Canadian economy overall will do better than most in the world, thanks to rising energy prices. “With oil and natural gas prices to set new highs next year, energy will become as dominant a force in the world economy as it was during the oil shocks of the 1970s and early 1980s,” he warns. Although Canada will become much more of a global energy player than it ever was, he writes, the gains will be very unevenly spread across the country.

“While an energy boom will see real economic growth in Alberta soar by more than 7% next year, Ontario’s GDP will likely grow by less than 2%.”

Scotia economist Meny Grauman says British Columbia will be one of Canada’s top provincial performers, driven by energy, mining and construction activity. Non-residential construction, including infrastructure projects like expanding port facilities and preparations for the 2010 winter Olympics will provide extended gains. Alberta is expected to maintain its spot as the country’s top performer, while Saskatchewan and Manitoba are also expected to outperform.

Growth in Ontario on the other hand will trail the country in the next two years, even underperforming Quebec, thanks to the stronger dollar, higher electricity costs and the prospect of slower growth in the U.S., all pressuring growth and exports.

Filed by Kate McCaffery, Advisor.ca, kate.mccaffery@advisor.rogers.com

(12/23/05)

Kate McCaffery