Since the 2008 financial crisis, Canadian growth has largely dependent on consumer debt, with consumption and investments in residential housing acting being the main buoyant forces for the economy. But according to a new commentary, that dynamic is set to fade.
“[A]n elevated share of growth built on consumer debt and housing is ultimately unsustainable,” said portfolio managers from PIMCO Canada in a recent note. And while the Bank of Canada (BoC) is forecasting a rotation to growth fuelled by business investment and exports, the commentators from the firm are less optimistic.
Focusing on vulnerability in housing markets, they pointed to overheating in Vancouver and Canada as main points of concern. That, combined with federal rules to tighten mortgage credit and policy hike-driven increases in some mortgage rates, already slowed the country’s housing markets in 2018. “[A]lthough the path of house prices in 2019 is unclear, we think the risk is weighted to the downside,” they said.
The cooling housing markets, they expect, would result in less consumption because of a reverse wealth effect. The most indebted consumers are likely to tighten their belts as they get squeezed by higher rates; meanwhile, wage growth has been falling over the past six months or so, which the BoC acknowledged in its downward-revised forecast for consumption growth this year.
Turning to business investment, the PIMCO Canada managers pointed to the BoC’s estimates of a 0.5% decrease in real GDP growth resulting from lower oil prices. The central bank noted some positive signals in its recent Business Outlook Survey, but given persistently lackluster business investment around the world since the end of the financial crisis, the managers took the view that 2019 will be a year of continued “serial disappointments.”
Finally, they called into question the robust export forecast underlying the BoC’s 2019 real GDP estimate. “While the new NAFTA (aka USMCA) has been agreed by political leaders, it faces challenges passing the U.S. Congress, with the potential for more drama in the U.S. before it becomes law,” they said. Trade talks between the US and China, they added, have massive implications for global trade, asset prices, and business/consumer confidence. Those factors, they said, suggest choppy seas ahead for Canada on the trade front.
They acknowledged that strong employment growth and fiscal stimulus from the election-year federal budget could provide meaningful upside risks. But taking all of their research into account, the managers predicted that the headwinds to the economy would necessitate a neutral rate of 2%-3%, with a bias to the lower end of the range. The BoC’s current estimate is slightly higher at 2.5%-3.5%, but that’s due for an update in April’s Monetary Policy Report.
“We will pay very close attention in April to see if the BoC changes its neutral rate estimate and the rationale behind the decision,” they said. “Often the devil is in the details when it comes to bond investing.”
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