Economic growth, housing slowing after fast start to recovery: Bank of Canada

OTTAWA, Ont. – Canada’s economy grew at the fastest pace in a decade at the start of the year, but the extraordinary burst of activity, including the country’s housing boom, is fizzling out, the Bank of Canada said Thursday.

The central bank estimates that Canada’s gross domestic product grew 5.8 per cent in the just completed first quarter, following a five per cent advance in the previous three-months period at the end of 2009.

The Canadian economy hasn’t expanded so rapidly since the fourth quarter of 1999, when it advanced by 6.8 per cent.

But the bank cautions that much of the activity is a result of front-loaded spending by Canadians as a result of extraordinary government stimulus and low interest rates, and that economic activity actually remains well below pre-recessionary levels.

The country’s production output gap is two per cent below capacity, it said, and the Canadian economy won’t return to full capacity for another year.

That front-loading of activity is especially evident in Canada’s booming housing market, which the bank
predicts is about to go bust as higher interest rates and sated demand kick in.

“Investment in housing is projected to weaken markedly though the remainder of 2010 and 2011,” said the bank’s Monetary Policy Report, a comprehensive analysis of the Canadian and global economies.

On Tuesday, the bank’s governing council removed its conditional promise to keep interest rates at record lows until at least July, a move economists and markets interpreted as a signal the policy rate will be hiked as early as June 1.

Housing, which is contributing about 0.6 per cent to economic growth this year, will actually be a slight drag next year, the report forecasts.

For the bank, that is a good thing because it regards the housing market as too hot for home-buyers’ own good. It has warned repeatedly that households should make sure when they purchase a home that they will be able to afford the monthly payments once interest rates rise.

In the main, the bank’s view for the Canadian economy and the world is actually brighter than the previous published analysis issued in January.

And it sees no double-dip in global economies as governments start withdrawing the trillions of dollars in stimulus they have been pumping in.

The world economy will grow at around four per cent for the next three years, the bank says, led by China and other emerging countries. This should help Canada’s export sector, the bank said.

The advanced countries, which borrowed heavily to soften the blow from the 2008-09 recession, will pay for in lower activity going forward. Europe will be the weakest major economic region, with growth rates of 1.2 and 1.6 per cent over the next two years.

The Canadian economy will grow by 3.7 per cent this year, 3.1 per cent next, and 1.9 per cent in 2012.

The bank sees the high Canadian dollar as a major impediment to stronger growth going forward, but also cites aging demographics and the low productivity record.

The U.S., with a younger work force and productivity improvements advancing at twice Canada’s rate, is projected to grow by 3.5 per cent in both 2011 and 2012.

In a recent speech, bank governor Mark Carney called for Canada’s corporations to start investing in modernizing their operations to improve efficiencies and compete more effectively in the global economy.

The outlook’s projections assumes that corporations will in fact step up investment in machinery and equipment, but it notes sharply that at the moment, business investment is actually a drag on growth.

“Business fixed investment fell (in the fourth quarter of 2009),” the bank said. “Firms have remained cautious, waiting for additional evidence of a durable recovery in demand, particularly in the United States.”

The bank said it expects Canada’s business sector to start contributing positively to growth this year, noting that government stimulus spending is phasing out and will actually weigh down growth in 2011.

The bank also issued a more detailed explanation of its fears about inflation that provides more ammunition to analysts who expect Carney to raise the policy rate from 0.25 per cent to 0.5 per cent at the next opportunity, June 1.

The report said underlying inflation is higher than it had expected it to be at this point in the recovery because wages unexpectedly held up during last year’s recession. Shelter costs have also increased faster than expected, it said.

The bank also warns that Canadians can expect prices to receive a 0.6-per-cent boost after July 1, when Ontario and British Columbia move to a harmonized sales tax.

The new tax will cut costs to businesses, however, and the bank said cost savings will likely be transmitted into prices in the second half of they year and trim inflation by 0.3 percentage points.

Total inflation, the amount Canadians actually see when they go to the store, will be higher than two per cent for the rest of this year before returning to target in the second half of 2011, it said.