Economic forecast ruled by commodities, loonie

A soaring Canadian dollar and increased international demand for commodities will continue to dictate the direction of the Canadian economy, according to economic reports from BMO Capital Markets and Scotiabank.

Persistent international demand for resources is fuelling growth, which is booming for most of the country, but the same factors have had a paralyzing effect on the economies of Quebec and Ontario, which are heavily dependent on manufacturing.

Both higher energy costs and a higher loonie have, as the BMO report puts it, “a double-drag” on central Canada’s manufacturing sector. For the foreseeable future, there does not seem to be any end in sight to this, says BMO Capital Markets’ senior economist Michael Gregory.

This is because the Canadian dollar’s strength is closely tied to the strength in commodity prices, which continue to rise.

“We just have to take a look at the latest numbers we got out of China, one of the biggest and fastest growing markets for our raw materials,” Gregory says. “They just had the strongest growth — above 11% year over year — for the last 12 years. They haven’t even started to pick up.”

Gregory says the best the Canadian manufacturing sector can hope for right now is stability. In order for that to happen, the Canadian dollar would have to recede to the mid- to low-80 cents US mark.

“I think the Canadian dollar is going to remain well above 90 cents US for the foreseeable future,” Gregory says. “Even if the dollar was to go well below 80 cents, the manufacturing industry has to address some more fundamental issues about its competitiveness and productivity.”

The result is that Ontario will have the slowest growing economy in Canada, a dubious distinction it hasn’t held since the nasty recession of 1991. BMO puts its growth over the next year at 1.8%, and Scotiabank estimates it will grow 1.9%. Quebec won’t fare much better, with expected growth of 1.9%, but with less exposure to the auto sector and more capital investments in sectors such as the aerospace industry, the provincial economy is rebounding from a paltry 1.7% growth rate last year.

On the opposite end of the growth spectrum are the western provinces and Newfoundland and Labrador. The oil and gas sector is expected to continue to be a major engine of the Canadian economy, and it will help Newfoundland and Alberta experience the fastest growth, at 5.7% and 4.5% respectively.

Newfoundland’s newfound growth is largely due to its offshore oil revenues, which are expected to increase 30%, and a resurgence in mining. But both banks say its tenure at the top of the heap will only be temporary due to a declining population and very little growth in infrastructure.

The banks predict strong demand for virtually all commodities, particularly agriculture, which has also helped create a boom in the previously sluggish economies of Saskatchewan and Manitoba. Manitoba is expected to post 3.4% growth, and Saskatchewan is expected to experience 3.7% growth.

“We’re starting to see a run-up in a lot of agricultural products as well, such as potash, corn and wheat,” Gregory says.

Neither bank expects a reverse in the current economic trends anytime soon, particularly the east–west economic disparity. Although Gregory says over the longer term, the dollar’s value may subside.

BMO Capital Markets is predicting resurgence in the U.S. economy, which should help raise its currency in comparison to the loonie. In addition, he says the current run on the loonie is being largely fuelled by speculation regarding interest rate increases by the Bank of Canada.

“We do think that the BoC will raise rates in September, and there is some risk for maybe October, but for the time being, we think they will stop after that. The mere fact of stopping will take some of the lift from the loonie’s wings,” he says. “If we are correct in our prediction that U.S. growth will start to bounce back next year, the U.S. dollar will improve next year, which will also put a little bit of a damper on the loonie.

Filed by Mark Noble, Advisor.ca, mark.noble@advisor.rogers.com

(07/20/07)

Mark Noble