December 1, 2012
VANCOUVER, BC, Dec. 1, 2012/ Troy Media/ – The global economy remains in a growth recession, loosely defined as growth less than 4 per cent, which will extend into 2013.
Tentative signs of firmer growth in China are emerging. If policymakers in the U.S. fail to reach a compromise on the looming fiscal cliff, that economy undergoes a significant setback. The European economy is back into recession and many policy hurdles remain with any misstep keeping it in recession through 2013. A low interest rate environment will prevail until the economy grows at a faster pace and begins to absorb excess capacity.
An upturn in the U.S. economy is critical for the global economy to emerge from its growth recession and for higher interest rates. Europe will be an exception since its unused capacity and growth inhibitors will keep down inflation and interest rates for several more years.
The upward revision to U.S. third quarter 2012 growth to 2.7 per cent from 2.0 per cent initially reported and from the anemic 1.3 per cent in the second quarter appears more positive than the underlying details reveal. While that was the best performance this year, it was based on inventory accumulation and a large increase in defense spending. Excluding these two temporary gains, growth would be closer to 1.5 per cent.
The near term outlook is clouded by the impact of Superstorm Sandy and by the fiscal cliff outcome. Disruptions in the Northeast on production and consumption due to the storm will negatively affect incoming economic data releases in the fourth quarter. Reconstruction spending will lift GDP in the coming quarters as will a resumption of spending to replace an estimated 100k to 200k damaged vehicles for example.
Negotiations on the fiscal cliff are underway and they will likely produce a compromise mitigating all or part of scheduled tax increases and spending cuts. Most observers expect a deal before year-end but, if not, the fiscal hit to the economy and the political heat on policymakers would soon spur a new set of negotiations. This is the greatest near term risk to the economic outlook.
Should the fiscal cliff hit in its entirety after Jan. 1, 2013, real GDP would contract in the first quarter, climb just above zero in the second quarter and pickup in the second half. For 2013 as whole, growth would be around 1 per cent. In this scenario, bond yields, equity markets, and commodity prices decline while unemployment rises. No forecaster in the monthly consensus survey has the ‘over the cliff’ scenario as the base-case scenario.
Some additional fiscal tightening will occur in 2013 and beyond. It is just a matter of how much and when.
There is upside potential to growth should a credible fiscal plan be achieved. Fourth quarter economic growth below 2 per cent is very likely and could be as low as 1 per cent, given the temporary boosts in the third quarter and the storm’s impact. Assuming no significant fiscal tightening, quarterly growth in 2013 will range between 1.5 per cent and 2.5 per cent with a stronger second half resulting in above 2 per cent growth for the year. With less policy uncertainty, further recovery in the housing and consumer markets along with net exports, the U.S. economy could grow above 3 per cent in 2014.
Europe’s economy is back into recession and looks to remain in recession well into 2013. Leading economic indicators do not signal any improvement in the near term. Fiscal drag, tight credit conditions, high unemployment, and declining real personal income will continue to restrain consumer and business spending.
Progress on the policy front continues at a slower than desirable pace, but the latest deal on Spanish banks is positive. Many decision hurdles remain.
China’s growth trajectory is at or near an inflection point. The November HSBC flash manufacturing PMI was up and it portends a gain in the final PMI issued in early December. When viewed in the context of the prior two monthly gains in the PMI along with other indicators, faster growth ahead is likely.
Another bout of slower growth cannot be ruled out but with considerable room for policy stimulus, any slowdown should be temporary.
Slower growth continues to evolve in Canada and will very likely extend into the fourth quarter, especially with a weak fourth quarter upcoming in U.S. economy. The Bank of Canada’s rosier fourth quarter forecast of 2.5 per cent growth looks increasingly in jeopardy.
While October housing sales held onto September’s modest gain, the market is in a soft patch. Tighter federal mortgage insurance rules in July caused a demand downshift with the economic slowdown and lower consumer confidence contributing factors.
In some markets, such as B.C.’s lower mainland, housing sales were trending lower prior to the mortgage insurance changes and have seen lower prices for a few months. In other markets, prices are beginning to plateau and will probably roll over. In contrast, prices continue to rise in some Prairie markets.
Housing starts will begin to reflect the sales slowdown and weaker market conditions. Less construction takes some growth out of GDP but given the time lags involved, it will become more evident after mid-2013.
The composite leading indicator rose in October at a modest pace suggesting a continuation of the current slow growth pattern. Canada’s third quarter growth is put at 1.0 per cent with the fourth quarter at 1.8 per cent. For all of 2012, growth is forecast at 1.9 per cent with 2013 at 2.0 per cent and 2014 at 2.6 per cent. The forecast risk is on the downside into 2013 with upside risk dependent on substantive policy actions in the U.S. and Europe.
Consumer Price Index (CPI) inflation held at 1.2 per cent in October, the same as in August and September. Core inflation at 1.3 per cent was also unchanged from September. Food and gasoline showed the largest increase in prices from a year ago. Inflation in Canada will remain below the Bank of Canada’s 2 per cent target in the near term due to below potential growth.
Bond yields bounced around in November but generally ended at lower yields than in October. There was a small change in three-year posted mortgage rate, which declined 15 bps to 3.70 per cent.
The big news was the announced departure of the head of the Bank of Canada, Mark Carney, to assume the position as the next Governor of the Bank of England. This has sparked some speculation on a possible shift in monetary policy under a new Governor.
While there may be a different style or approach by a new Governor, the foundations of the monetary policy framework will not change – price stability at a 2 per cent inflation rate.
In addition, the Governor is one member among six at the Governing Council, and while the Governor probably has more sway than other members, the Governor has only one vote. It is very likely there will be no significant change in the conduct or goals of monetary policy in Canada because of Carney’s departure. The Governor has been replaced on several other occasions without any material change in monetary policy.
Interest rate forecast
No rate change is expected at next Bank of Canada meeting. Economic conditions requiring the removal of monetary stimulus are not likely to materialize until early 2014. Monetary tightening when it occurs will be gradual and administered in phases.
The futures market is more pessimistic on the economy with the first 25 bps increase expected not until September 2014 followed by another more than one year later.
Market expectations are overly negative on the economic outlook. It will not take much to see expectations change quickly and by a large amount. A fiscal deal in the U.S. would do the trick and knock the market out of its pessimistic perception.
There is room for a small decline in the three-year and five-year GIC rates. Posted mortgage rates look to hold at these levels from a cost of funds perspective, but market competition in a softer real estate market could nudge rates lower.
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