Canada's Economy is Going to Cool Off But How Much is Not "Predetermined"

Focus Economics has just released its October 2017 Consensus Forecast for Major Economies and the numbers for Canada bear some consideration in the wake of our recent surge in real GDP growth.  Annualized GDP growth in the second Quarter of 2017 for Canada according to Focus Economics was 3.7 percent – the highest in all the G7-which averaged 2.2 percent.  The world economy grew at 3.2 percent; the United States came in at only 2.2 percent while Germany managed only 0.8 percent.  So, Canada seems to be on a roll.

However, looking ahead at the 3^rd and 4^th quarters and into 2018, the GDP growth rates start to come down.  Canada’s 3^rd quarter of 2017 is forecast at 2.7 percent while the 4^th quarter comes in at 2.5.  As for 2018, the 1^st quarter is forecast at 2.5 percent, the 2^nd at 2.1 and the remaining quarters at only 2 percent each.  Canada is still expected to outperform the G-7, which by the 4^th quarter of 2018 is expected to see only 1.8 percent average growth.  However, the gap between Canada and the G-7 narrows considerably.

Part of what is going to cool off the Canadian and G-7 economies is the anticipated rise in interest rates.  The rate for three month T-bills in Canada was at 0.54% in 1^st quarter of 2017 but is expected to rise to 1.72 percent by the 4^th quarter of 2018.  The average for the G-7 has it going from 0.54% to 1.14% suggesting that rates in Canada are currently expected to rise faster than other G-7 countries.  Over the same period, 10-year bond yields are expected to rise from 1.63% to 2.56% in Canada and from an average of 1.48% to 1.91% in the G-7. 

Of course, these interest rates are all still quite low by historical standards but think of them another way.  From the 1^st quarter of 2017 to the 4^th quarter of 2018, Canadian T-bill rates are expected to undergo an increase from 0.54% to 1.72% - a percent point increase of 1.18 points but a percentage increase of over 200 percent.  In other words, there is a doubling of debt service costs.  Moreover, this increase is greater than the average for the G-7. 

The coming slowdown in Canadian economic growth is going to be driven by two interest rate effects.  First, the rise in interest rates will affect borrowing and investment by Canadian consumers and businesses.  Second, Canadian interest rates rising faster than the United States and other G-7 countries means that all other things given, the Canadian dollar can also be expected to appreciate relative to other major currencies also affecting our exports. 

In the end, much depends on how quickly Canadian interest rates continue to rise.  Stephen Poloz, the Governor of the Bank of Canada in last week’s address in St. John’s remarked that there was “No predetermined path for interest rates from here” suggesting that future rate increase are by no means preordained.    Of course, this introduces a certain amount of variability into forecasts as well as some uncertainty into the expectations of consumers and businesses.  In the end, what this also means is that the amount of cooling off the Canadian economy may face over the next 18 months is also not predetermined.