Canadian outlook skewed toward the downside, says Vanguard

Trade and consumption headwinds are the major sources of friction to the country’s economic prospects

Canadian outlook skewed toward the downside, says Vanguard

While Canada’s economy grew above trend in 2018 in spite of the moderating housing sector and uncertainty in trade negotiations with the US, mounting challenges are creating a less optimistic projection for next year.

“In 2019, we expect the economy to grow below trend, falling short of the central bank’s projection of 2.1% GDP growth,” Vanguard said in its economic and market outlook for 2019. With rising interest rates and an expected moderation in US growth, the firm predicted that downward pressure on the Canadian economy will convince the policy-tightening Bank of Canada to stay its hand at least for the first half of the year.

Global oil prices rose during much of 2018, but pipeline challenges restricted Canada from capturing the benefits fully. Vanguard analysts foresaw that in 2019, logistical constraints and weakening global demand for oil will further weigh on the oil sector’s contributions.

Looking at trade agreements with European and Pacific partners, along with the newly signed United States-Mexico-Canada Agreement (USMCA), the firm said Canada remains in a good medium- to long-term position for increased trade. But its short-term position looks soft as the US, which buys 75% of Canada’s exports, is anticipated to undergo moderate growth in the coming year.

“The U.S. housing and auto sectors, which are especially sensitive to rising interest rates, are important sectors for Canadian exports,” the report said. “Weaker demand from the U.S. coupled with lower commodity prices will result in a greater drag on Canadian exports than policymakers currently estimate.”

On the domestic front, the firm saw flashing alarms as debt-servicing costs eat up a growing share of household incomes. “Interest paid on mortgages and other consumer debt is now rising faster than disposable income, reflecting the five rate increases implemented by the Bank of Canada since mid-2017,” Vanguard analysts said. While increasing leverage, refinancing, and reducing savings are possible short-term options, they’ll become less viable over time.

That means there will be a lagged decrease in consumption as Canadians cut back on spending to deal with their existing debt. Vanguard analysts argued that while the Bank of Canada projects household spending to contribute 1.2% to GDP growth in 2019, it fails to consider high levels of household leverage and rising debt-servicing costs that will likely be felt next year.

“Downside surprises to growth in this sector will be important to monitor in the coming year, as household expenditures make up nearly 60% of Canadian GDP,” they said.

With a sharp deceleration below trend growth and Bank of Canada forecasts in the cards, Vanguard saw risks skewed to the downside for the national economy. Should a worse-than-expected slowdown occur, it could drive further depreciation of the Canadian dollar against the US dollar. A fall in housing prices from elevated valuation levels will further dampen consumer sentiment and compress household net worth.

There are still potential tailwinds for the economy. A resolution in the US-China trade dispute would spur global trade growth; additionally, continued tightness in Canada’s labour market could allow higher-than-expected wage increases. “Federal and provincial fiscal policy has remained disciplined and could provide additional stimulus, depending on the pace of economic growth and the results of upcoming elections,” Vanguard added.


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