| || ||Glen Hodgson |
Senior Vice-President and Chief Economist
Forecasting and Analysis
| || ||Michael Burt |
Canadian Industrial Outlook
The biggest economic story in Canada so far in 2014 is the Canadian dollar and who may “win” or “lose” from its current descent. The Conference Board’s assessment is that the drop in the dollar, if sustained, would have a small net positive impact on economic growth in the short term. Some exporters may (emphasis on “may”) benefit, but consumer prices are also likely to rise.
Arguably more important than the value of the loonie is the signal it sends about the Canadian economy. Markets are betting that the Canadian economy will continue to underperform. This assessment is consistent with our own forecast, which calls for U.S. gross domestic product to grow by 3.1 per cent in 2014, much better than Canadian growth of 2.3 per cent. Given the lack of confidence in Canadian growth prospects, the depreciation of the loonie is hardly an unqualified good news story.
The loonie has fallen below US$0.92 for the first time since 2009—a drop of 5 per cent in a little more than two months. This decline follows a similar dip last fall, from near par to around 95 cents. Some of this decline can be attributed to Canada-specific factors—much lower gold prices, heavy personal debt levels, or a tepid outlook for employment and GDP. Commodity prices alone cannot explain the dollar’s movements—the Bank of Canada’s commodity price index is little different today than it was at the end of October.
Instead, the strengthening of the U.S. economy relative to the Canadian economy is driving the changes in exchange rates. Global investor confidence has now shifted in favour of the U.S. dollar, the euro, and a few other major currencies, and against the Canadian dollar. Currency traders now view the U.S. and much of Europe more positively, and global currency values have shifted accordingly.
All else being equal, a weaker loonie will make many Canadian exporters more cost competitive on international markets, which should boost exports and corporate profitability. Canadian exports have been surprisingly slow to recover from the 2008–09 recession. However, it is not clear if Canadian exporters will be able to fully capitalize on a weaker dollar.
Canada’s manufacturing capacity in many export-dependent industries—such as autos and parts—was slashed during the financial crisis. Thus, we may not be able to quickly rebuild it. And market and production conditions in many industries continue to shift. For instance, one factor limiting the recovery in Canadian exports of autos and parts has been a shift in U.S. production toward southern states, far from Canadian suppliers.
Furthermore, for sectors with high levels of trade integration, such as auto or aircraft manufacturing, the import content of their production may exceed the domestic content. This means that the weaker loonie will raise their import costs at least as much as their export revenues, limiting the benefits.
A declining loonie will also hit all Canadians in the pocketbook. It makes us all a bit poorer as consumers by increasing the prices for most of the things we import. Higher prices would be expected to erode real wage gains, limiting the purchasing power of consumers and slowing real growth in consumer spending, which is the single largest component of GDP.
For years, Canadian consumers enjoyed the dampening effect of the strong loonie on prices for a variety of products—ranging from staples, such as food and gasoline, to apparel, electronics, and even autos. A prolonged weakness in the loonie will reverse some of these benefits. Indeed, the strong loonie partially explains why consumer inflation in the U.S. has outpaced the Canadian figures over the past decade.
That said, some additional inflation may not be a bad thing. At a time when deflationary forces have emerged in Canada, a small dose of imported inflation may actually be welcome for the Canadian economy in the near term, since it helps to stave off the risks of deflation.
Exchange rates are determined by a truly global market. The loonie’s value today is consistent with some estimates of purchasing power parity (PPP), which is its estimated long-term value. Just as there was no simple way to slow the pace of the currency’s appreciation as the Canadian dollar soared after 2003, there is no simple way to stem the loonie’s decline as it searches for a new balancing point. Strap yourself in … we’re in for a bumpy ride.