Choose Your City
Change City

Canada a tale of two economies: as export sector staggers, domestic activity booms

OTTAWA - Canada's comparatively strong domestic economy and weak export-based industrial sector is presenting a quandary for the Bank of Canada as it prepares to weigh in on the surging dollar and its low-interest rate policy.

OTTAWA - Canada's comparatively strong domestic economy and weak export-based industrial sector is presenting a quandary for the Bank of Canada as it prepares to weigh in on the surging dollar and its low-interest rate policy.

Two reports Thursday reinforced recent trends of a strengthening domestic economy propped up by floor-low interest rates and a recovering housing market, being undermined by a weak manufacturing base staggering from poor demand and a sky-high dollar

The most recent evidence is the outsized growth in house sales during the third quarter - given the still weak overall economy.

The Canadian Real Estate Association reported that in real terms, sales of existing homes in the country have never been stronger. The association said more than 135,000 units were sold in the July-to-September period - 18 per cent higher than the corresponding period last year before the recession hit.

Home sales were up in over 80 per cent of the local markets across the country as the average home price rose 11 per cent to $327,736.

"What it's telling us is that low interest rates are working in Canada," said CIBC chief economist Avery Shenfeld.

"We've had a number of disappointments on the export front. Where Canada is showing vigour, it's on the domestic front in response to low interest rates."

The hot resale housing market along with better new-home starts is also putting the central bank governors meeting on interest rate policy next Tuesday in a fix, says Douglas Porter, deputy chief economist with BMO Capital Markets.

"While the hot housing market cries out for rate hikes, the runaway loonie screams "No"!" he explained.

Lower rates in Canada will keep downward pressure on the Canadian dollar, while higher rates make it a more attractive currency for money traders.

The loonie cooled somewhat Thursday to below 97 cents US, but analysts expert it will reach parity by year's end. One respected U.S. analyst, Dennis Gartman, who was in Toronto, believes that once the loonie passes the greenback, it could stay above parity for "several years."

That is the worry of those who want the Bank of Canada to intervene, because as they point out, the "other economy" - exports - are missing out on the recovery.

Statistics Canada figures released early Thursday confirmed recent depressed trade numbers in reporting that factory shipments fell 2.1 per cent in August as the activity from the U.S. cash-for-clunkers program subsided. The program had temporarily spurred auto sales in the United States, helping Canadian production, but its benefits were fleeting.

As well, there are few signs of recovery for the battered manufacturers going forward. New orders have practically stagnated and unfilled orders fell 4.2 per cent, the agency said.

"The fact remains that Canada's manufacturing sector remains under duress," said TD Bank economist Grant Bishop, noting the new challenge of a dollar.

A perhaps even bigger barrier to a recovery in Canada's export sector, which accounts for about one-third of the economy, is that consumer demand in the U.S. for what Canada has to sell - cars, parts, lumber and consumer items - isn't about to pick up any time soon.

A new Conference Board of Canada forecast for the U.S. economy estimated that consumer spending will remain in the dumps throughout 2010, rising only about one per cent from already abysmal levels.

The problem faced by the Bank of Canada is that hinting it may raise rates sooner rather than later will only add fuel to the loonie's flight and further harm exports and manufacturers.

Suggesting that rates will remain as low as they are for a long time, say to the end of 2010, feeds into a housing asset bubble and risks inflation.

Economists say the market has already factored in a Bank of Canada rate hike this spring, months before governor Mark Carney's "conditional commitment" to keep the policy rate at 0.25 per cent until the summer.

The C.D. Howe monetary policy panel is recommending a stand-pat position for the time being, but 10 of the 11 economists surveyed believe the policy rate should at least triple to 0.75 per cent six-to-12 months from now.

The expectation of a central bank move has already resulted in Canada's chartered banks to raise mortgage rates by up to a third of a point on five-year loans.

However, mortgage rates are still extremely low by historic standards, and Shenfeld says the central bank has bigger fish to fry than putting out an overheated housing market.

"That's a boom we need right now given the challenges from the global economy and the strength of the dollar and what does that to our exports," he said.

Some industry groups are calling on Carney to tackle the dollar directly.

Currency intervention has a bad reputation, mostly because it hasn't worked in the past, but that's because the bank was trying to support a wounded loonie with a limited amount of foreign currencies at its disposal, labour economist Erin Weir points out.

Now it needs to suppress interest in the loonie, and there governor Carney can literally print all the money he needs to convince markets it would be folly to keep speculating on the currency, he explained.

"The Canadian economy has survived much larger deviations from our dollar's fundamental value at various times in history," he said, "But today we are in the midst of a severe economic crisis. Because Canadian exporters already have their backs against the wall, the Bank should be less tolerant of an overvalued Canadian dollar."

You Might Also Like