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Forecast 2016: Now, the Energy Fallout

Posted on December 18, 2015

Look for U.S. consumer spending to give Canadian manufacturers, and the economy, a boost

Kingston, ON – Dec. 18, 2015 — For those who prefer to see the glass half full, Evan Dudley says the Canadian economy is projected to enjoy marginally more growth in 2016 than this past year, though admittedly that’s hardly a stretch goal.

But if you’re a more realistic sort, Dudley, assistant professor at the Smith School of Business, advises to keep your fingers crossed that the manufacturing sector can pick up where the chastened energy sector left off.

Speaking at the recent Smith School of Business Forecast Luncheon, Dudley offered a look ahead at Canada’s economic prospects for the coming year.

As he points out, two big drivers of the economy are moving in opposite directions. The mining and oil and gas extraction sector, which makes up 9 percent of Canada’s GDP, is contracting, while manufacturing, responsible for 10 percent of GDP, potentially could benefit from global forces.

The misfortunes of energy-related industries will cast a pall on the Canadian economy, Dudley says. The slump in capital spending by this sector will hold GDP growth to around 2 percent.

The energy sector will also continue to have an outsized impact on the Canadian dollar, which in recent years has looked like a petrocurrency. As the price of oil goes, Dudley points out, so goes the Canadian dollar. “In the past year they moved one for one,” he says. “The price of oil falls, the price of the Canadian dollar falls. Are we a petrocurrency? I hope going forward the Liberals can steer the economy away from the reliance on the energy sector.”

Can manufacturing pick up the slack? The best predictor of that, Dudley says, is U.S. consumer spending, which has been driving Canadian non-energy exports. The strong U.S. recovery, therefore, is a welcome development north of the border.

Canadians will also be looking closely at U.S. monetary policy. With the U.S. Federal Reserve now raising interest rates for the first time since 2006, Dudley says upward pressure will build on bond rates here. This would have a ripple effect: in Canada, bond rates drive mortgage rates. Mortgage rates drive household spending.

“If there are high mortgage rates, home prices may fall and we know that consumers buy more when they feel they are rich,” says Dudley. A 0.6 percent increase in mortgage rates could reduce home prices by up to 10 percent.

Even though the Bank of Canada has signalled that it would keep interest rates low, long-term rates over which it has far less control are going up. That will hurt some parts of the economy and lead to less growth than the Bank of Canada has anticipated.

“I’m struck by how little control we have over Canadian economy,” Dudley says. “We’re so dependent on what’s happening outside our borders. The price of oil has been affected by demand in China, and our interest rate policy is going to be affected by the rates in the U.S.”

The 2016 Forecast

•    Real GDP growth rate (Q3 to Q3): 2%
•    Inflation rate: 1.75%
•    Unemployment rate: 6.75%
•    Interest rate (prime): 2.7%
•    Exchange rate (US/CDN): 0.70

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