Innovation

Podcast 34 Transcript: Fall economic outlook

Written by Ian Portsmouth

Ian: : Welcome to the Business Coach Podcast, an advice-oriented series that tackles the top issues and opportunities facing Canada’s small businesses. I’m your host, Ian Portsmouth, the Editor of PROFIT Magazine and we’ve developed this podcast in cooperation with BMO Bank of Montreal.

Autumn has arrived and this year, it is ushering in more than fall colors and falling temperature. We’ve got collapsing investment banks, plunging stock markets, rising inflation and volatile commodity prices. So what better time for the Business Coach to get an economic update from our friends at Bank of Montreal. On line is Sal Guatieri, Senior Economist with BMO Bank of Montreal. Sal, welcome to the Business Coach

Sal: Thanks Ian.

Ian: : So a lot of people are following the federal election run-up. The other day, Prime Minister Harper said “Our economic fundamentals are strong on the whole.” Are they strong?

Sal: Yes, on balance, Canada’s economic fundamentals are fairly healthy. First off our inflation is generally low and although gas prices have risen quite significantly and other energy costs and even food costs are starting to move up a bit. But for the most part, most prices are rising very modestly and in some cases falling. For example, auto prices and boat prices have been falling for the past year. So inflation is fairly low and likely to get lower and that means interest rates will probably stay quite low for some time. And as well, we are seeing fairly good income growth for Canadian workers benefiting from relatively high commodity prices and the high employment rate. A lot of Canadians, in fact a record number of Canadians are working. As well, the federal government is running a surplus and that gives it some flexibility to support the economy by raising spending or cutting taxes if we start to slump a bit further. I guess the one weak spot is that productivity remains fairly soft in Canada but I think Canadian businesses will start to focus more on that and boost their efficiency going forward. So basically, small businesses should expect fairly low inflation and interest rates but may need to work on boosting productivity a bit.

Ian: : In the midst of all of this economic strength, we’ve got this big shake out on Wall Street. How worried do small business owners need to be about what’s happening down in the U.S.?

Sal: Well, we are quite worried about the situation and I presume most Canadian small businesses are concerned. What we are seeing in the U.S. financial market is virtually unprecedented in modern times. So we are seeing extreme distress in the landing markets and credit markets. We are seeing credit spreads that are widening, borrowing costs are going up for a lot of people, a lot of businesses and banks. Virtually the only place that is going down is for the U.S. government. And we are seeing the availability of credit is getting tighter so there are less funds available to borrow. And that means the U.S. economy is under a lot of stress right now and that’s why it has been slumping and we think will remain quite weak for quite sometime. And there certainly is a risk of a deeper recession in the U.S. Obviously that would have negative implications for Canada if the U.S. did slide even further. And more directly all the distress on Wall Street I think is causing Canadian consumers and businesses to pull back a little bit. They are uncertain about the future, about how the situation will resolve itself. So we are seeing a declining Canadian business confidence and that could lead to a little softer spending going forward.

Ian: : It sounds like a bit of a self-fulfilling prophecy.

Sal: That’s right. The advice we would give for businesses is “Hope for the best but prepare for the worst”. But the good news is eventually, I would hope by this time next year, we are well out of this situation and on the road to recovery.

Ian: : Now, a few months ago, the Canadian dollar was well above a buck U.S., it has dipped significantly in the past few weeks. Is it low enough right now to help exporters bounce back? I think we are looking at about 93 cents.

Sal: Yes, I think we are getting towards levels were the Canadian dollar is allowing Canadian exporters and manufacturers to regain their competitiveness on the global stage. Certainly when the Canadian dollar was at parity or worst above parity with the Green back, we are seeing a tremendous pull-back in exports and manufacturing activities. Canada’s trade balance at least in real terms was sliding quite dramatically and of course detracting from our economic performance. I think, at least by our estimates, the Canadian dollar would likely need to move a bit lower, perhaps toward ninety cents U.S. or the high eighty cent U.S. range and that in our view would be a more competitive value for the Canadian dollar for most Canadian exporters and businesses.

Ian: : And what is your forecast for the dollar, how soon do you see it getting down to those levels?

Sal: We see it getting down into about eighty eight cents over the next couple of years. We would think it will probably hit ninety cents or so by this time next year and then slip a bit further toward that eighty eight cents in a couple of years. And again our sense is that’s a value that makes Canadian companies a little more competitive. Right now, if we compare prices in the U. S. with those in Canada, U.S. has quite an advantage in the fact that they have lower prices than in Canada. So just on that basis, it looks like somewhere in the high 80 cent range would be an appropriate value for the Canadian dollar.

Ian: : Now we have also seen a significant softening in the housing market north of the border. How does this bode for the consumer spending?

Sal: Well, housing markets continue to moderate over the next year. We’re coming off record high levels of sales and prices last year and it is starting to cool down now. We are seeing existing home sales for example down about 19% in August from a year ago and house prices down about 5%. Now a lot of that weakness is concentrated in several cities where prices ran up quite a bit in recent years for example Calgary and Vancouver. And now the commodity prices have pulled back a bit, you are seeing some softening in their housing markets. Now just based on affordability which has been reduced because of the rising house prices in the recent years, I think we will see a further softening nationwide in Canada’s housing market which might mean prices will come down moderately further. We certainly don’t expect a repeat of the U.S. situation simply because Canada’s lending standards were not as loose as those in the U.S. and I think most Canadians didn’t buy more house than they could afford as compared to the U.S. So we are not expecting a bust by any means for Canada’s housing market but it will continue to cool down. I think what that means is Canadian consumers may soften their pace of spending on household items, for example appliances, furniture, certainly renovations if they see prices kind of cooling off a bit.

Ian: : Now commodity prices generally over the shorter term have been dropping. How far do you see them retreating in the next year or so?

Sal: We don’t think that commodity prices will fall too much further from their current levels. Now, it is possible if the global economy continues to weaken or slips into a recession, commodity prices would come under pressure. But our general sense is borrowing a global recession, commodity will probably level out somewhere around current levels. For example, oil prices just below one hundred dollars now, we think oil prices will probably stay around that level for a while maybe even hit a little bit higher. Now longer term, we are generally optimistic on commodity prices given a supply constraint that we are seeing in a lot of regions and for a lot of resources and as well we should continue to see over the long run strong demand for commodities from the emerging nations that are growing quite rapidly. But near term, perhaps a little more down pressure on commodity prices but longer term we should see prices remain relatively high.

Ian: : Earlier on in our conversation, you mentioned that inflation rates were not rising particularly fast, you didn’t think they would be and that they are pretty low to begin with. But I know there has been a significant difference in recent times between the headline inflation rate and the core inflation rate. So what’s your inflation rate forecast and will we see those headline and core rates converge?

Sal: We certainly think they will converge and that’s with the high headline rate right now converging with a much lower core rate. Right now CPI inflation in Canada just about 3 % a lot of that of course or pretty well all of it reflects the tremendous search we’ve seen in commodity prices over the last six years. The commodity prices in Canada simply have tripled in the past six years. Now they are all above 16% in the last few months. But it is the high energy costs and to some extent, higher food costs that have pushed the CPI higher. Now if you look outside those areas, the core measure of inflation in Canada is still at 1.5% in fact that is a bit below Bank of Canada’s 2% target. And again we are seeing for most prices, they are rising very modestly and in some cases falling for example for automobiles and books. But we generally see over the next while as long as commodity prices don’t renew a sharp upper trend that over inflation will come back down towards the lower core rate probably settle around 1.5% to 2% over the next year.

Ian: : And finally what is your GDP outlook both for the country as a whole and any regions of note?

Sal: Well, for the economy, we are certainly not in the optimistic camp at the moment given the tremendous head winds blowing in from south of the border and to global credit markets. So we’re generally looking at Canada’s economy growing very modestly maybe at 1% in the second half of this year. Now that would be an improvement on an essentially flat activity in the first half of this year but it is certainly not something to ride home about. And it is certainly well below the economy’s normal or potential rate of growth which is closer to 2.5% and 3%. And again until we work through the problems in the U.S. economy and housing market and to the problems into global credit markets, our growth rate will probably remain quite subdued. In fact, it may not be until the second half of next year 2009 that we see more normal rates of growth in the 2.5% and 3% range. And of course, that would mean a fairly tough business environment for Canadian small businesses. Now it depends which areas of the economy you’re doing business, of course I think the western provinces Alberta BC will still retain relatively healthy rates of growth in the 2.5 – 3% range as long as commodity prices remain relatively high. Of course, Ontario, Quebec, the Eastern portions of the country will likely face much lower growth. In fact for Ontario, we are probably not going to see much growth at all this year and only a modest recovery next year given the U.S. economic slump which is hitting our exports and the restructuring that is going on among the big three automakers.

Ian: : Well, Sal you have given us lots to think about and hopefully it all still applies a week from now.

Sal: That’s my hope too.

Ian: : Sal Guatieri is Senior Economist at BMO Bank of Montreal. He spoke to us from his office in Toronto.

That’s it for another episode of the Business Coach Podcast. But sure to check out other episodes which you can download from BMO.com, profitguide.com and iTunes. Now, if you have any comments or suggestions about the podcast, then please send them directly to me, my email address is ian.portsmouth@profit.rogers.com.

Until next time, I am Ian Portsmouth, Editor of PROFIT Magazine and I wish you continued success.

Originally appeared on PROFITguide.com