Ian: Welcome to the Business Coach Podcast, an advice-oriented series that tackles the hot issues and opportunities facing Canada’s small businesses. I am your host Ian Portsmouth, the Editor of PROFIT Magazine. And we’ve developed this Podcast in cooperation with BMO Bank of Montreal.
There is no bigger business issue these days than the state of the U.S. economy. Is it going into recession? Is it already in recession? In either way, what will the impact be on Canadian business owners? Joining us to answer those questions and more is Michael Gregory, Managing Director and Senior Economist with the Economics Department at BMO Nesbitt Burns in Toronto. Michael, thanks for joining the Business Podcast.
Michael: Thank you.
Ian: So Michael, big question, we all know the U.S. economy is slowing down but how slow is it? Is it already in recession?
Michael: We suspect that it already is in recession. The January indicators that have come out have been particularly weak, a decline in employment, even in the services side of the economy, that great work horse that is the largest segment of the economy, actually contracted as well. So it does seem like the U.S. economy has slipped into recession, the big question now, how long will it be in recession and how deep will that recession be?
Ian: So what is your forecast for the near term?
Michael: Oh, we look for the contraction to last just about a couple of quarters with growth shrinking by about 1% annualized over the first half of the year. That I would call a short and shallow recession. And, but now [inaudible] the risks are that it could be a little deeper and perhaps a little prolonged.
Ian: And what are those risks, what could make it deeper and more prolonged?
Michael: Well, there are a couple of things going now right now. Firstly, confidence is beginning to buckle, consumer confidence is suffering not only from the decline in home prices and the tightening up of credit conditions but equity markets are proofed volatile so basically household wealth is being, is quite vulnerable and it looks like it may drift down.
On top of that, consumers are paying elevated energy bills because of high energy prices and job growth has slowed quite considerably, in fact shrinking in the latest months. So, all four of these factors are weighing on consumer confidence and consumer spending has started to slow, and that now has rippled over to business confidence. Where businesses are getting worried about the prospect so they’re not going to hire as much and they’re not going to spend as much on machinery, equipment. So the big worry is that confidence is starting to really pull it down, and that would be sort of the key risk.
The other one is whether or not the credit head-wins that we have in the U.S. economy now continue to be a challenge, and even if interest rates are cut, nobody is interested in either taking out loans or making loans. So that is the other risk to the economy.
Ian: Ok, so the 1 ¼ point drop by the Fed might not make much of a difference?
Michael: That’s true. You are beginning to hear a lot of talk now about the old adage pushing on a string. Low interest rates of course help the economy but what they are really designed to do is to provide a little more support to credit base spending in the economy getting banks to make loans, to businesses and consumers to buy big ticket items and stuff they finance with loans, and for of course businesses and consumers wanting to take out loans. And it is not at all clear whether we are really at that point yet and that probably is, like a number one down side risk for the economy right now.
Ian: And what about this big spending package that the Bush Administration recently announced. Is that once that money gets into the market place, is that going to help?
Michael: Well, it is going to help and it is a big amount, whether it is $150 billion $170 billion, there is a lot of packages being circulated right now. But it will provide literally a 1% stimulus to the economy now. Some of that money in the hands of consumers a little bit businesses but mostly in consumers will be saved, some of it will be used to pay down debts but a big chunk of it will be used to spend. And we think consumers will spend and that combined with further interest rates reduction by the Fed through the remaining of the first half of this year probably will set the stage for a stronger economic activity towards the end of this year.
Ian: Well, that’s good news. Now it’s often said that when the U.S. sneezes, Canada catches a cold. So given what’s happening south of the border, what is your near term growth forecast for Canada?
Michael: Well, I think we will catch a cold. I mean, growth in Canada is going to slow. I mean, it’s already been undermined by the strong Canadian dollar and particularly, you know, for manufacturers but when you add in the fact that the U.S. economy is going to be slipping into a recession, and therefore U.S. consumers and businesses will buy less goods made in Canada, that will just layer upon the head-win from the Canadian dollar and push growth slower.
And we are looking for growth to weaken but not dip into negative territory. In other words, we do no think that Canada will slip into a recession growth, it will be a slow growth, it will be what we call in the economics world, growth recession, growth below potential but not actually in negative territory. And so, I guess that is good news and part of that reflects the fact that other parts of the domestic economy once you get past the exporting and manufacturing side of the economy, you find it’s still doing relatively well. And that’s providing a bit of momentum to the economic growth.
Ian: Could there be a drop in consumer and business confidence in Canada tough because of what’s happening in the States?
Michael: Well, I think that the major reaction for consumers and businesses is when they see problems in the U.S., they think, wow, it’s going to happen in Canada in the near future. But the fact is that Canada has a couple of things going for it. Firstly, we still have high commodity prices and that is providing a big income boost mostly to Western Canada but still to Canada generally. So that’s one positive feature. The other positive feature which suggests that Canada will be able to skirt a down turn in the U.S. is that we don’t have the housing collapse, the housing mess that is the root of the problems in the U.S. economy right now and in fact, our housing sector while it seems to be leveling off, it seems to be cooling a little bit but still remains quite robust.
Ian: A federal budget is going to be coming out in the next couple of months, is there anything that you are expecting in that, do you think that will have a big impact on the economy?
Michael: Well I think that we are at the point now where after cutting taxes last autumn both the GST and the retroactive cut in personal tax rate which we’ll all get the benefit of when we file our tax return this year, there is not a lot of money left over for any big new initiatives. I suspect that we will see smaller initiatives probably targeted initiatives, perhaps those designed to alleviate the adjustments going on in the Canadian economy but I think the federal government with an eye of maintaining a surplus probably is not going to engage in anything that would risk turning into a deficit.
Ian: Now, it really is difficult these days given recent experience to predict where the dollar is going, but where do you see it going let’s say by the end of the year?
Michael: Well, I think there is a couple of factors driving the Canadian dollar now. But the most important one is commodity prices. I mean, it’s often said the Canadian dollar is the commodity link currency and in fact it is, it is one of the key drivers of its value. And right now, commodity prices are still high but we believe that when we go through a period of weaker U.S. growth, weaker Canadian growth, European growth, Japanese growth will also slow, so in other words, what we are going to get is a U.S. recession spelling over into a slow down in the G7 which we believe will be enough to put a little bit of a damper on commodity prices towards the end of this year and that suggests that the Canadian dollar while it may trade kind of side ways, you know, within a cent or two of parity, that it will likely start to dip down towards the end of this year. Right now, we are looking at 95 U.S cents is our year-end target and unfortunately for a lot of businesses that may be waiting for the currency to return back to less onerous levels, say in the mid or low 80 cent range, we don’t think that we’ll be getting there.
Ian: So it’s still going to keep flying high.
Ian: Michael, we certainly have in interest in you here ahead of us. Thanks for sharing your predictions with the Business Coach.
Michael: Thank you.
Ian: Michael Gregory is the Managing Director and Senior Economist with the Economics Department at BMO Nesbitt Burns in Toronto.
That’s it for another episode of the Business Coach Podcast. You can download other installments of this series from BMO.com, profitguide.com or iTunes. And as always, I’d love to hear your feedback and suggestions for future topics which you can send to email@example.com
And until next time, I am Ian Portsmouth, the Editor at the PROFIT Magazine, wishing you continued success.