For as long as he’s been governor of the Bank of Canada, Stephen Poloz has been promising that exports would replace commodities and housing the driver of economic growth. The “rotation,” took longer than he expected it would, but finally, two months ago, Poloz declared victory. “The export recovery is alive and well,” he said.
Contrast Poloz’s July remarks with this observation from the Bank of Canada’s latest policy statement, released Sept. 7: “Exports disappointed even after accounting for weaker business and residential investment in the United States, adjustments in the resource sector, and cutbacks in auto production.” As a result, the central bank said economic activity likely has been “somewhat” weaker than it expected when it last updated its forecasts in July. The summer issue of the Monetary Policy Report had gross domestic product expanding 1.3% in 2016, a sizable drop from the spring forecast of 1.7%. Canada will never have grown slower in a calendar year this far removed from a recession.
The central bank’s fresh disappointment wasn’t so great that the Poloz and his inner circle of advisers on the Governing Council felt a jolt of monetary stimulus was necessary—they left the benchmark rate unchanged at the ultra-low level of 0.5%, as everyone on Bay Street thought they would. But while policy makers emphasized the positives, it is difficult to read the 421 words the central bank published this week and not conclude that conditions are getting worse, not better. “If the bar was previously set high for cutting the policy rate, it is suddenly less elevated today,” said Sébastien Lavoie, chief economist at Laurentian Bank.
Let’s keep in mind that we are talking about shifts in marginal probability. The baseline for the Bank of Canada and most every other forecaster is that Canada will continue to crawl its way back to a more satisfactory level of economic output. Lavoie continues to think Poloz will simply keep the benchmark rate fixed at 0.5% through 2017. The central bank said in the policy statement that it expects a “substantial” economic rebound in second half of the year, as Alberta recovers from the wildfires and Prime Minister Justin Trudeau’s spending program kicks in. The central bank also predicted the global economy would strengthen “gradually” in the months ahead. That should boost demand for imports from Canada’s trading partners.
But by how much? It has become clear that something isn’t right in the global trading system. In July, Poloz and his senior deputy governor, Carolyn Wilkins, celebrated the fact that exports had almost returned to their pre-crisis levels. Almost. It’s been nearly eight years since Lehman Brothers Holdings Inc. collapsed, triggering the Great Recession. The conditions for stronger exports—a weaker currency, economic growth in the U.S., cheap money to finance expansion—have been in place for a long time.
A couple of Royal Bank of Canada economists, Nathan Janzen and Gerard Walsh are among the more recent to attempt an explanation for why the old method for stoking an export boom no longer seems to apply. They offer three explanations:
- the Canadian dollar has remained strong against currencies such as the Mexican peso, suggesting Canada remains uncompetitive against its rivals for U.S. market share;
- Canada’s exports to the U.S. are driven by business investment, not household consumption, and industrial production has been tepid this year; and
- global trade flows are trending lower now that companies have completed a structural shift to supply chains.
Janzen and Walsh used these assumptions to build a model for estimating future exports. The results lined up with past export performance, suggesting they are onto something. Their model predicts exports will continue to expand at the same lacklustre pace of recent years.
There’s still a hint of wishful thinking in the Bank of Canada’s defence of its export narrative. Poloz and Wilkins put little emphasis on the possibility that global trade could be fundamentally different today than it was a decade ago. That hopefulness was on display again this week. The central bank chose to highlight the newest monthly trade figures as “encouraging.” Statistics Canada reported on September 2 that non-energy exports surged 4.1% in July, the most since December, and that Canada’s trade deficit narrowed to $2.5 billion from a record $4 billion in June. Yet, as Poloz and other central bank officials have observed many times, it is folly to make too much out of one month’s data. StatsCan noted that total exports were 7% lower in July than a year earlier.
Perhaps July numbers will prove to be the start of a rally. Hopeful or not, the central bank isn’t counting on exports to power Canada’s economy in the short term. It said in the statement that it expects economic growth will be “above potential” in the fourth quarter, or faster than the pace that would normally put upward pressure on inflation. Not that there is any worry about Canada’s economy overheating. The central bank also said the weaker-than-expected growth likely has increased the odds of it failing to stoke annual inflation to its target of 2%. And that’s why Bay Street reckons interest rates will be low for a long time yet: Canada’s economy has a lot of ground to make up.
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