Canada’s central bank still dreaming of an export recovery

January 19, 2016

Bank of Canada Governor Stephen Poloz looks on during a Canada-UK Chamber of Commerce event in central London March 26, 2015. REUTERS/Stefan Wermuth   - RTR4V02N

The dramatic plunge in the Canadian dollar must surely be a test of optimism, and patience, for Bank of Canada Governor Stephen Poloz.

Ever since he took office two and a half years ago, Poloz has pinned his hopes on an export-based revival in Canada led by a weaker currency and stronger U.S. demand. But that does not seem to be happening yet.

Free-falling oil prices, two interest rate cuts by the Bank and the first policy tightening in the U.S. in nearly a decade have sent the Canadian dollar to a 13-year low of C$1.45. But that still has failed to coax on an export-based turnaround in the economy.

According to CIBC research, a near 20 percent depreciation in the currency should boost exports by around 12 percent with a lag of roughly six months to a year and a half.

CIBC VAR model

It has been a year and a half since the price of oil, a major Canadian export, collapsed and first began to take the Canadian dollar down with it. Oil has plunged more than 70 percent and the currency has lost about a third of its value.

But there has been no discernible rebound in exports yet.Canada exports and dollar

Avery Shenfeld, chief economist at CIBC, said:

The difficulty with those sorts of results is that all else is equal. That’s based on a statistical analysis of what’s happened in the past with the drop in the exchange rate.

The difficulty is that all else is not equal, particularly global growth which has slowed. So we are getting the combined positive benefits of a weaker exchange rate but we are feeling a negative impact of sluggish global growth. And also of late, a sluggish U.S. manufacturing sector which is relevant because Canada is a supplier too to that part of the U.S. economy.

Recent evidence shows that exports can perform well even when the Canadian dollar is relatively strong. Just recently, it traded near parity with the greenback over a period of several years.

Emanuella Enenajor, senior economist at Bank of America Merrill Lynch, said:

You need not only a weaker currency but stronger demand from the U.S. economy. And for now if we look at industrial sector indicators, if we look at fourth quarter GDP tracking in the U.S. which could be around 1 percent or less (and) I think we are not there yet. It may be a bit premature to expect an export-led recovery in Canada.

Recent trade data showed Canada’s bilateral surplus with the U.S. – its biggest trading partner – barely moved despite the sharp fall in the loonie.

Economists have consistently downgraded their growth forecasts for the U.S. economy since last year, suggesting any material pickup in demand for Canadian goods will take much longer than desired.

Meanwhile, the violent drop in the currency is making firms worried about a fall in consumer spending.

Ten percent of firms in the recent Business Outlook Survey conducted by the central bank expect inflation to be below 1 percent in the next two years.

Growth prospects remain elusive and so more stimulus may be ahead.

Slightly more than one in three analysts in a recent Reuters survey expect Canada to slip into a recession again this year and may warrant another rate cut, perhaps as early as its Jan 20 meeting.

But interest rates are already close to zero at 0.50 percent and lessons from last year’s policy easing suggest while a rate reduction may help stimulate the economy to some extent, it could exacerbate trouble with already high levels of household debt. The household debt-to-income ratio hit another record of 163.7 percent in the third quarter, just when the economy crawled out of its slump.

Many have warned further policy easing could fuel an already-overheated housing market and raise the risk of a crash.

But Governor Poloz continues to play down such a scenario.

A growing number of analysts are now saying monetary policy alone will not be able to do the heavy lifting for the Canadian economy. Fiscal policy may have to underpin growth from here on in.

Shenfeld from CIBC noted:

If we want to avoid the shock of a 60-cent Canadian dollar, we’ll need to use the fiscal weapon rather than more monetary easing as the next leg to support the economy.

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