Exports and business investment finally showing signs of taking over
from consumer spending and housing
TORONTO, Sept. 4, 2014 /CNW/ - Unexpected growth in consumer spending
and residential construction have seen the Canadian economy outperform
in 2014, but continued low interest rates and a cheaper loonie are
necessary to sustain growth going forward, finds a new report from CIBC
The report notes that while Canada's economy will see better than three
per cent growth in both the second and third quarters, the drivers are
not sustainable. "Neither housing nor consumption funded from a falling
savings rate can be the permanent drivers of growth, so all eyes will
be on capital spending and exports," says Avery Shenfeld, Chief
Economist at CIBC. "The market's response will be less about getting
two and a half per cent growth to close the output gap, than about the
policy backdrop needed to do so."
Mr. Shenfeld expects the U.S. economy to continue to improve and
Canada's to track along with it but with the countries taking a
differing approach to monetary policy. "We're not at zero, so there's
less urgency to begin dialing down the stimulus. But more critically,
Bank of Canada Governor, Stephen Poloz wants growth led by exports and
capital spending. There's no specific FX target, but a weaker Canadian
dollar will be a key ingredient in restoring competitiveness and making
Canada an attractive place to expand capacity."
He says this will be achieved by letting the U.S. eliminate the entire
Canada-U.S. short-rate differential before we see even one Bank of
Canada hike. A much weaker loonie could then allow the Bank to carry on
to a 1.5 per cent overnight rate by year end 2015.
Co-authors, Benjamin Tal and Nick Exarhos write that an improving
economy stateside has already started to help Canadian exports.
"Geography always makes the U.S. key to Canada, but America's
outperformace vs. other G-7 countries is enhancing that dependence. In
fact, exports destined to the U.S. market are already growing at a near
17 per cent year-on-year pace, while those destined elsewhere up by
just under 11 per cent."
However, much of the current momentum is coming from energy exports, now
delivering a quarter of Canada's dollar value of outbound shipments.
Estimates from the Canadian Association of Petroleum Producers suggest
that black gold's shine isn't likely to fade any time soon. Applying
production estimates to their relatively stable historical relationship
to exports destined for the U.S., suggests that Canada in 2016 will
have exported more than 230 million additional barrels than it did in
But energy's growing share also reflects what was, until very recently,
a lacklustre performance by other exporters. The Bank of Canada
identified sectors like forestry products, machinery, aircraft
products, and other electronics as key in carrying the next leg of
Canadian export resurgence, but this group has actually trailed other
non-energy exporters in the past year.
A key factor in this is that many non-energy exports historically came
from sectors sensitive to the exchange rate. The long period in which
the Canadian dollar was overvalued led to exits of plants from this
country, taking out the capacity that would now typically be responding
to better news stateside.
With the weaker value of the Canadian dollar providing a more
competitive exchange rate and positive price shocks for some products
such as food, the loonie-sensitive sectors have seen an 11.8 per cent
gain in nominal exports in the past twelve months, vs. 8.7 per cent for
other non-energy industries.
"But there is much more to do ahead," says Mr. Tal. "There are lags
before the full impact of the late 2013 depreciation will be fully felt
by existing plants. And we will likely need even more time, and a still
weaker exchange rate, to prompt the entry of new production facilities
that can start to fill the void left by earlier exits.
"Thus far, after the steepest correction in the post-war period, and an
initially strong rebound, capital spending is well below where it
typically should be at this more mature stage of the cycle. And the
issue is not capability. Our business capability index, which uses an
array of indicators to measure the ability of Canadian firms to spend,
is close to a record high. That suggests that financial limitations
aren't the culprit. It's all about the willingness to invest."
He notes that Corporate Canada appears more inclined to spend on bricks
and mortar or takeovers elsewhere. "Foreign direct investment (FDI) by
Canadian companies rose by a record high nine per cent in 2013—the
exact opposite of the decelerating growth trajectory in capital
spending at home. The ratio of the outflow of FDI to capital
expenditure is close to 20 per cent—again a record high."
But he says that at some point businesses have to invest in existing
facilities at home. Right now a growing proportion of each capital
spending dollar is devoted to replacement investments that simply
maintain existing levels of production. The practical implication is
that capital investment must rise much more quickly in order to
accommodate both replacement and expansion investments.
There are signs that, despite some reservations, spending is about to
accelerate. Mr. Tal says the Bank of Canada's Business Index is now at
a level that, in the past, was consistent with real business investment
climbing by close to five per cent on an annual basis.
Mr. Shenfeld says that with the backdrop, corporate earnings still have
room to run. "Our top-down model, which ties key economic indicators -
such as Canadian and U.S. GDP and various resource prices - to bottom
line results, projects TSX Composite earnings growth of 11 per cent in
2015. That's above the historical average. Bond yields will provide
some noisy volatility for stocks, but double digit earnings gains
should still see major indexes close next year at moderately higher
The complete CIBC World Markets report is available at: http://research.cibcwm.com/economic_public/download/fsep14.pdf
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SOURCE: CIBC World Markets
For further information:
Avery Shenfeld, Chief Economist, CIBC World Markets Inc. at (416) 594-7356, email@example.com or Kevin Dove, Head of External Communications at (416) 980-8835, firstname.lastname@example.org.