Rates poised to soar as economy slips
A red-hot economy in the United States may force Canada's hand, analysts warn
Eric Beauchesne
The Ottawa Citizen, April 29, 2000
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Marje Fletcher, The Ottawa Citizen / GDP Falls: The gross domestic product fell 0.4% in February, the first drop in 19 months. However, it was still 3.8% higher than February 1999.
The Canadian economy, after three consecutive interest rate increases over the past half year, has unexpectedly stumbled, ending the longest uninterrupted monthly expansion on record.
The news from Statistics Canada yesterday, that the economic output fell 0.4 per cent in February, came only a day after the United States reported that the economy, despite five straight rate hikes there over the past year, was still steaming ahead at an annual pace of more than five per cent.
Analysts here are confident the Canadian economy will rebound but fear it could be tripped up again by a further runup in interest rates, engineered by the U.S. Federal Reserve, which is trying to rein in that giant steamroller of an economy.
"That's a real downside risk," said Mario Angastiniotis, economist at MMS International, who warned that it could take a further three full percentage point increase in interest rates "or even a bit more" to bring the U.S. economy to heel.
"It's going to take a lot more increases than people are currently factoring in," he said.
"That's a big risk, but hopefully Canada will not have to match all the U.S. rate increases."
But rates were already on the rise yesterday, with several major banks announcing across the board increases in mortgage rates of as much as one-fifth of a percentage point.
The slump in February was the first monthly decline in 19 months. It was led by a broad-based drop in manufacturing, particularly auto production, as well as weakness in construction and retail and wholesale activity, which was only partially offset by strength in the stock market.
"This decline followed three months of particularly strong growth," the agency noted.
"Moreover, the level of activity in February was still greater than that of December 1999, and 3.8 per cent higher than in February 1999."
The agency also suggested that the auto industry would rebound, noting that there is no sign of an abatement in consumer demand for autos in the U.S., where 90 per cent of Canadian-made vehicles are shipped.
Mr. Angastiniotis saw the setback as merely a "pause in a healthy uptrend."
However, the economy faces a further runup in interest rates, noted analysts who said that the Bank of Canada will still likely match the expected increase in U.S. interest rates next month to protect the currency.
The question, however, is how many more U.S. rate hikes will the bank be willing to match and the impact those increases will have, not just on the Canadian economy, but also the U.S., Canada's largest export market.
There has been speculation that the Bank of Canada may not now match even next month's expected increase in U.S. rates, Mr. Angastiniotis said.
That speculation added to the already sagging loonie's weakness yesterday, knocking a further quarter cent off its value, and leaving it to the mid-67 cents U.S. level from what was more than 68 cents U.S. earlier this week.
"But we're still thinking that the bank will be left with no choice to match the U.S., whether it's a quarter or even half-point increase," Mr. Angastiniotis said.
"If it didn't, the currency would take a hit."
CIBC economist Josh Mendelsohn agreed, saying not matching the U.S. rate hikes and living with a weaker currency would be worse for the economy in the long run than matching rates.
A weaker dollar would make it more costly for Canadian businesses to invest in needed new technology, most of which is imported, he said.
Mr. Mendelsohn is also optimistic the Canadian economy will continue to grow at a healthy pace despite higher interest rates, thanks to the strength of the U.S. economy and its appetite for Canadian imports.
The bank, he said, is sticking with its latest forecast released yesterday that the Canadian economy will grow 4.2 per cent this year, matching last year's growth and that all provinces would share in the expansion to varying degrees.
The CIBC forecasts provincial growth rates ranging from highs of five per cent in Ontario and and Newfoundland and 4.5 per cent in Alberta to lows of 2.5 per cent in Saskatchewan and Prince Edward Island, and 2.6 per cent in British Columbia.
But higher rates pose a double threat to the Canadian economy -- both slowing growth in its largest export market, the U.S., while dampening consumer spending and business investment here. Royal Bank economist Craig Wright agreed that the economy's performance in May was "much weaker than expected."
"Expectations were for a modest gain and what we saw was fairly large decline," he said. "It was disappointing but not devastating."
And as such, he also expects the central bank will match the next U.S. rate hike if it's only one-quarter point.
However, he added that it might not match a half point hike if that's how much U.S. rates rise in the wake of this week's evidence of wage inflation. |
