Wednesday, July 15, 2009

Canada's "normal" recession turning into a "normal" recovery

I have been pretty "positive" about Canada. Compared to the U.S., the Canadian economy simply sits on a firmer (financial) foundation: housing fundamentals were stronger going into this mess; unemployment created a migration pattern toward work; saving rates are rising as in the US, but on a smaller wealth effect; and the overall GDP loss in the current cycle is expected to fall short of a recent time-series of Canada's recession.

But the standard policy response, lowering the policy target to stimulate consumption and investment, has been the same: the Bank of Canada (BoC) lowered its policy rate, the overnight rate, to 0.25%. It did not (correctly) engage in quantitative easing measures - and I believe that it has not officially announced that such measures have been taken off the table - because it is becoming evident that the economy is responding to the massive monetary stimulus already in place.

And Merrill Lynch's new chief strategist and economist for Canada, Sheryl King, criticized the BoC for being too aggressive. From the Globe and Mail:
In her report, Ms. King actually upgraded Mr. Wolf's Canadian gross domestic product forecast for 2009 (she's now calling for a decline of 2 per cent versus 2.7 per cent in the old forecast) and 2010 (growth of 2.7 per cent versus 2.3 per cent). She also suggested that the improved growth prospects over the next 18 months are policy makers' own doing – the flood of fiscal and monetary stimulus “will produce growth.”

And she warned that the Bank of Canada “overreacted to the downside risks” and may have positioned itself to do the same on the upside. She fears that the short-term growth fuelled by policy-driven economic stimulation could artificially boost inflation and output, fooling the bank into tightening its policy too soon.

“It's hard to get monetary policy right at the best of times,” she said. “The probability that [the Bank of Canada's current policy] is exactly the right tonic for the economy is so infinitely small, it's laughable.”
She might be right. Canada doesn't have the strong productivity growth to offset inflation pressures coming from the demand side. And it is becoming quite clear, especially in the housing market, that low interest rates are stimulating some economic activity.

The Canadian Real Estate Association reported a surge in Q2 existing home sales:
National resale housing market activity bounced back strongly in the second quarter of 2009 above levels reported for the same period last year. Demand continues to rebound sharply in some of the most expensive markets in the country, skewing the national average price upward.

According to statistics released by The Canadian Real Estate Association (CREA), actual (not seasonally adjusted) home sales, via the Multiple Listing Service® (MLS®) of Canadian real estate boards, totaled 147,351 units in the second quarter of 2009 – the fourth strongest quarterly sales figure ever. Up 1.4 per cent from the second quarter of 2008, this marks the first year-over-year increase in quarterly activity since the fourth quarter of 2007.
The national average home price also scaled new heights on a monthly basis, climbing 3.6 per cent year-overyear to $326,613 in June 2009. However, only 13 local markets posted new average price records in June, less than a handful of which are among the most active or expensive. The strong rebound in sales activity, not price, in Canada’s most expensive markets is skewing average prices upward nationally and in some provinces, just as a sharp decline in activity in these markets skewed the average lower in late 2008.
Although the re-sale market is really heating up, especially in the high income bracket, new home prices are still falling, -3.1% over the year in May 2009. From Statistics Canada:
Contractors selling prices decreased 0.1% in May following a 0.6% decline in April.

Between April and May, prices declined the most in Saskatoon (-1.2%) followed by Hamilton (-1.1%) and Edmonton (-0.9%). In Saskatoon, a number of builders reported reduced material and labour costs while other builders have lowered their prices to be more competitive and to encourage sales.
And building permits are growing in the single-family home sector, rising for three consecutive months in May. This is usually a leading indicator of new construction in the residential space.

And other types of big-ticket items are likely responding to low financing rates. Auto sales, driven by a surge in truck sales, are stabilizing and actually grew in May. However, preliminary reports indicate a drop in June.

Overall, the economy is stabilizing on the heels of big monetary and fiscal stimulus. And unlike in the US, we are starting to see first-derivative signs of growth. The housing market will (and always) plays a significant role in the early stages of an economic recovery.

When the recovery starts to firm a bit more (Q3 growth is projected to be weak, 0.0% by the Bank of Montreal), we will see if King is right - whether or not the BoC was indeed too aggressive. I wouldn't be surprised if they were.

Rebecca Wilder


  1. I'm not that positive on Canada. The housing thing is only the good part. What about trade, the auto mess, the high manufacturing inventories? No first-derivatives there.

    The shaky Greenback puts upward pressures on the Canadian dollar (see this week)...not good for their exports. I think their exports count for something like 40% of GDP? Throw in protectionism from the U.S. where nearly all these exports are headed...Plus, oil is trading below break-even for Canadian tar sands. I had read that their housing boom had been driven by the health of the commodity industry.

    I really can't imagine Canada decoupling from the U.S. into the recovery when they're just so dependent on us and on things they can't even control. It seems to me that Ms. King turned what looked like a decent forecast into an overly optimistic forecast. Not that Canada won't stabilize, they will and so will we but it's probably gonna be at the same time and not very soon.

    Besides, it's easy to criticize the Bank of Canada in hindsight but I think they would have been really dumb NOT to be aggressive because they would probably have boosted their currency even more. Not exactly something they would want.

  2. Hi Jones,

    You bring up some good points – especially about inventories. The Canadian inventory cycle is lagging that in the US, and will continue to drag growth until they pop back (I say that intentionally, because inventories are quite volatile).

    But the point is: that the stimulus is actually “stimulating” economic activity. One cannot say with any sort of clarity for the Federal Reserve’s policy.

    And as for hindsight – that is exactly what the Bank of Canada should not rely on. I do applaud them for not engaging in QE measures – that would make the recovery a bit more uncertain.

    The auto sector is clearly going to drag economic activity – but it has been for quite some time. Going forward, it seems to me that commodity revenues can more than offset this drag as EM growth gets underway.

    Thank you for your insightful comments, and please come back!


  3. On QE, the Bank of Canada published an internal examination (The BoC uses in-house analysis extensively) on QE, and found it wanting.

    I'm not too sure if I posted reference to this prior, but I will search for the reference.

    I believe Carney had made reference to it a few weeks back but my recall is cloudy today.

    Some of the points Jones makes are addressed my Canada having a much greater margin for handling the downturn to begin with.

    I have stated in the past that the housing situation in Toronto is very helathy, and Ontario is one of the hardest hit provinces. Oshawa and Windsor look grim, but much of the rest of urban Ontario isn't.

    I think Jones' questions are not so much 'if' but 'why?'

    I'll look for the BoC's QE paper...

  4. OK, oddly, just one Google result for the article I was looking for, but it is exactly the one I remember, as 're-enforce' is spelled wrong. (albeit the word makes more sense written this way)

    [Bank of Canada researchers said earlier this year that bond purchases by the central bank might disrupt financial markets, which may have shaped Governor Mark Carney’s decision not to match moves by U.S. and U.K. policy makers.

    “Central banks’ purchases of private assets could distort the capital and credit allocation process and induce lobbies from the private sector to purchase assets,” Zhaoxia Xu, a member of the Bank of Canada’s financial markets department, wrote in a Jan. 6 draft report. The paper was obtained by Bloomberg News through an access to information request.

    The success of any so-called “quantitative easing” would be hard to measure, and it’s difficult to identify the best assets to purchase, according to the notes. Buying non- government securities may also risk the bank’s independence, one of the researchers found.

    The Bank of Canada research “re-enforces their uncertainty,” about using quantitative easing, said Michael Gregory, senior economist at BMO Capital Markets in Toronto. He said the bank puts a lot of stock in its research.

    “When you move into QE it’s because you’ve exhausted interest-rate reductions,” he said in an interview. “The problem with QE is you aren’t sure how much you have to do” to get the economy growing again.

    Mr. Carney has said he doesn’t anticipate using quantitative or credit easing after cutting the benchmark interest rate close to zero in April to deal with a recession and global financial crisis. The Bank of Canada laid out guidelines in April for the possible use of quantitative easing.[...]]

    It id an extensive Reuters article, and well worth the entire read.

    I suspect Rebecca will wish to find the source of Carney's quote. It might be on the BoC website, and thus have much more gravitas.


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