TD Economics QUARTERLY ECONOMIC FORECAST THE FORTUNES OF CANADA S ECONOMY TO BENEFIT FROM AN IMPROVED GLOBAL BACKDROP

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1 QUARTERLY ECONOMIC FORECAST TD Economics THE FORTUNES OF CANADA S ECONOMY TO BENEFIT FROM AN IMPROVED GLOBAL BACKDROP Highlights For the first time in a year, TD Economics has upgraded its Canadian quarterly economic forecast. Real GDP growth is projected to run at.% in 1, representing an upward revision of. percentage points from our previous view in December. The most important development since our last forecast has been the progress made in containing the European financial crisis. Removing our assumption of a Greek default from the Canadian forecast and the expected knock-on effects on financial markets and confidence at home accounted for. percentage points of the upgrade to real GDP growth this year. Both exports and business spending are likely to benefit from an improved global backdrop. Lower-for-longer interest rates will provide additional stimulus to households, helping to offset the implications of sluggish income growth. However, high household debt and government fiscal restraint are likely to remain impediments to domestic spending and overall real GDP growth over the forecast horizon. For the first time in twelve months, TD Economics has upgraded its Canadian quarterly economic forecast. Real GDP growth is projected to run at.% in 1, representing an upward revision of. percentage points from our previous view in December. The catalyst behind this positive adjustment is an improvement in the near-term environment for the global economy and financial markets, which is expected to pay off in terms of higher world commodity prices, more robust exports and stronger confidence at home. Despite CANADIAN REAL GDP this bit of good news, we are not altering our general story of Annualized Q/Q % change modest overall growth in an economy challenged with a number 8 of domestic headwinds government deficits and high household 6 debt chief among them. Although the labour market is expected to snap out of its recent lull, prospects for job creation for 1 have not received a commensurate upgrade, as governments move to cut back payrolls and export-oriented businesses appear set to - meet increased demand through higher productivity. The nation s - jobless rate is predicted to hold at around 7.% this year before Fcst as of March -6 easing to 7.% in 1. Second half 11 surprises on the upside As the final brushstrokes were applied to 11, it was revealed that the Canadian economy emerged from the year in a slightly -8-1 Fcst as of December by TD Economics as at March 1 Source: Statistics Canada/Haver Analytics Craig Alexander, SVP & Chief Economist, Derek Burleton, VP & Deputy Chief Economist, Diana Petramala, Economist,

2 more resilient fashion than we had envisaged three months ago. At a lukewarm 1.8% annualized, the gain in real GDP in Canada in the fourth quarter of the year came in close to the expectations we had laid out in December. However, there were two surprises. The monthly pattern of the quarterly gain was more back-end loaded to December (+.% M/M) than we had expected due in part to some temporary factors that had depressed activity in the prior month. This positive hand-off will lend a helping hand to the economy s performance in early 1. The bigger surprise was the upwardly-revised, and impressive,.% turnout in the third quarter of 11, which lifted the second half showing to a solid average quarterly gain of % annualized. While consumers and homebuilders were active during the final two quarters, exporters stole the show with a robust average 1% advance. Among the key domestic engines, only the government exerted a major drag on growth, as its spending on fixed capital declined, reflecting the end of stimulus programs. International landscape improves While the momentum heading into the New Year was a tad stronger than anticipated, the more meaningful source of the upward revision can be traced to changes to the global economic backdrop. The most important development since our last forecast has been the progress made in containing the European financial crisis. Greece has managed to secure a second bailout and has achieved a private sector restructuring of Greek debt. In addition, actions by the European Central Bank to shore up liquidity in the banking sector appear to have eased the risk of a systemic global crisis. Granted, Europe s highly-indebted economies still Consumer Spending TD ECONOMICS 1 FORECAST year-over-year % change Business Investment Source: Statistics Canada, Haver Analytics F. by TD Economics as of March 1 March Revision December Outlook Housing Government Exports CANADIAN REAL EXPORTS & BANK OF CANADA U.S. ACTIVITY INDEX* Year-over-year % change Canadian Real Exports - U.S. Activity Index Source: Bureau of Economic Analysis, Statistics Canada, Federal Reserve, Bank of Canada. by TD Economics. *Index of U.S. GDP by sector, weighted by importance in Canadian exports have a number of large hurdles to overcome over the next several years. The implications of removing the seemingly imminent risk of a disorderly Greek default are three-fold: The slowdown in global growth this year will likely be less pronounced than previously envisaged at the time of our last quarterly economic forecast. Certainly, fiscal austerity will likely contribute to a recession in Europe, but the downturn is likely to be milder and the headwinds on the world economy less severe. Commodity demand and prices will remain more robust than was previously expected, adding an additional boost to Canadian income growth. For instance, the price of WTI crude oil is now expected to remain near US $1 per barrel for the balance of 1, compared to an expected dip to US $9 a barrel in our last quarterly economic update. This partly reflects increased geopolitical risk due to tensions with Iran. More generally, appetite for risk in world financial markets is assumed to be higher than what otherwise would be the case. This has been evident in the recent strength in equity and bond markets around the world. Above all, removing this event has provided a likewise boost to the outlook for the U.S. economy, which Canada is heavily reliant on for trade and financial flows. We remain somewhat cautious on the speed of the U.S. recovery in light of the significant medium-term headwinds that persist, specifically higher oil prices and future fiscal drag. Indeed, planned fiscal restraint stateside in 1 is likely to lead to a choppy export showing in that year. Nevertheless, the recent fcst

3 CANADIAN CONSUMER SPENDING AND EMPLOYMENT Year-over-year % change Consumer Spending Employment Source: Statistics Canada, Haver Analytics F. by TD Economics as of March 1 strength in job growth in particular suggests that the recovery is gaining traction. Sizeable pent-up U.S. household demand for motor vehicles is expected to trigger high-single-digit growth in Canadian light-vehicle production this year and next. Canadian exports of machinery, equipment and resources also enjoy solid prospects, despite the continued high value of the Canadian dollar, which we anticipate will average roughly parity over the next 1- months. With some of the dark clouds overhanging the global economy starting to dissipate and commodity prices strong, Canada s export-oriented businesses are expected to lead the way in ramping up capital spending in the coming quarters. The Canadian business sector, which has been paying down debt and hoarding cash in recent years, is likely to take advantage of the nation s much-improved business tax climate to retool and raise productivity levels. While businesses from all sectors of the economy look set to increase spending in 1 and 1, the most notable contribution is expected to come from the resource sector. Indeed, resource companies could comprise as much as a quarter of overall business investment in 1. The improved global financial backdrop and better domestic confidence has a significant impact on the Canadian outlook. Indeed, these factors added some percentage points to the growth rates of both business investment and exports this year alone and accounted for. percentage points of the upgrade to real GDP this year. Low rates to keep consumers in the game Another external development over the past few months that has influenced Canada s medium-term economic outlook was the U.S. Federal Reserve s move to announce a conditional commitment to keep its interest rate settings extremely low until late-1. While the Bank of Canada sets monetary policy independently, raising Canadian rates too far above U.S. rates would probably lead to a sharp and undesirable further appreciation in the Canadian dollar. Similar to our December call, we are of the view that the Bank of Canada will begin to withdrawal monetary stimulus by mid-1. However, the Fed s commitment prompted us to slow down the pace of tightening over the medium term. In the current forecast, the Canadian overnight rate is now expected to reach only.% by the end of next year. This revised outlook for Canadian interest rates will provide additional stimulus to households, helping to offset the implications of sluggish income growth. Over the past -6 months, job creation has stagnated and personal disposable income gains have been running at a sub-par rate on a trend basis. Just as rapid job creation earlier in 11 overstated the true strength in the labour market, the recent softness has overstated employment weakness. Our forecast for this year assumes a moderate pick up in job creation to about 1, per month which in our view is more consistent with an economy running at -.%. Still, virtually nonexistent wage growth is expected to keep household income gains in check, prompting many consumers to continue financing purchases through low-cost borrowing. Indeed, TD Economics projects that the aggregate Canadian household debt-to-income ratio could rise to new heights of 16% by late 1, up from its already-lofty level of 11%. Incidentally, 16% is the level hit in the U.S. and U.K. right before their households got into financial trouble CANADIAN EXISTING HOME PRICES Year-over-year % change Source: CREA, by TD Economics as of March 1

4 Annual % change REAL GOVERNMENT EXPENDITURES Source: Statistics Canada's National Accounts, Haver Analytics F. by TD Economics as of March 1 With low interest rates also continuing to support housing demand this year, the housing market is expected to remain moderately overpriced and overbuilt. TD Economics pegs the average price overvaluation at roughly 1-1%, with certain markets like Toronto and Vancouver loftier than others. We expect that the overvaluation will start to unwind once interests rates begin to increase in mid- 1. Beginning mid-way through next year and running into 1, we anticipate a nationwide sales decline of roughly 1%, while housing starts pull back to around 17, units. This year, however, we expect both sales and starts to oscillate relatively close to current levels. Tighter fiscal policy to weigh on near term growth As Canadians brace for what is likely to be a difficult government budget season, one component of the forecast that we have downgraded moderately since the December outlook is government spending. In recent weeks, finance ministers at both the federal and provincial levels have been signalling their intent to stay the course on deficit reduction and prospects for particularly bold up-front actions have increased to some extent. This is especially the case in Ontario in the wake of the Drummond Commission report on the reform of public services. Still, there are likely to be a few exceptions to the rule, such as Alberta s February 1 budget, where an outlook for strong economic and royalty revenue growth allowed the government to loosen its purse strings. More generally, governments appear to be targeting nominal spending growth of roughly 1% per annum over the next several years, which is consistent with a decline in real government expenditures of about the same magnitude. Conclusion still the same story While near-term Canadian economic prospects have changed for the better this forecast round, the underlying story we have been conveying one of modest economic growth and a relatively stable but stubbornly high jobless rate still rings loudly. What s more, despite the reduced potential for a systemic crisis in Europe, we are not prepared to abandon the key theme of a risk-filled environment that has been prominently featured in our recent quarterly forecast publications. As noted, Europe has a long way to go to emerge from its current problems. The threat to global growth from a supply-related spike in oil prices has recently returned to centre stage. Domestically, growing household credit imbalances remain the number one medium-term risk to Canada s economic fortunes. Overall, despite international improvements we remain cautious over Canada s near-to-medium term economic prospects. Craig Alexander SVP and Chief Economist Derek Burleton, Vice President and Deputy Chief Economist Diana Petramala, Economist

5 Period-Over-Period Annualized Per Cent Change Unless Otherwise Indicated Q1 Q Q Q Q1F QF QF QF Q1F QF QF QF 11 1F 1F 11 1F 1F Real GDP Consumer Expenditure Durable Goods Business Investment Non-Res. Structures Machinery & Equipment Residential Investment Government Expenditures Final Domestic Demand Exports Imports Change in Non-Farm Inventories ($ Bn) Final Sales International Current Account Balance ($Bn) % of GDP Pre-tax Corp. Profits % of GDP GDP Deflator (Y/Y) Nominal GDP Labour Force Employment Employment ('s) Unemployment Rate (%) Personal Disp. Income Pers. Savings Rate (%) Cons. Price Index (Y/Y) Core CPI (Y/Y) Housing Starts ('s) Productivity: Real GDP / worker (Y/Y) F: by TD Economics as at March 1 CANADIAN ECONOMIC OUTLOOK Annual Average Source: Statistics Canada, Bank of Canada, Canada Mortgage and Housing Corporation, Haver Analytics th Qtr/th Qtr

6 FINANCIAL INDICATOR OUTLOOK end-of-period level Q1 Q Q Q Q1F QF QF QF Q1F QF QF QF CANADIAN FIXED INCOME Overnight Target Rate (%) mth T-Bill Rate (%) yr Govt. Bond Yield (%) yr Govt. Bond Yield (%) yr Govt. Bond Yield (%) yr Govt. Bond Yield (%) yr--yr Govt. Spread (%) GLOBAL CURRENCIES USD per CAD USD per EUR JPY per USD F: by TD Economics as at March 1 Source: Statistics Canada, Bank of Canada, Bloomberg 6

7 CONTACTS AT TD ECONOMICS Craig Alexander Senior Vice President and Chief Economist CANADIAN ECONOMIC ANALYSIS Derek Burleton, Vice President and Deputy Chief Economist Jacques Marcil Senior Economist Diana Petramala Economist, Macro Francis Fong Economist, Macro and Special Studies Dina Cover Economist, Autos, Commodities and Other Industries Leslie Preston Economist, Financial Markets and Industry Sonya Gulati Economist, Regional Economies, Housing and Government Finances U.S. & INTERNATIONAL ECONOMIC ANALYSIS Beata Caranci, Vice President and Deputy Chief Economist James Marple Senior Economist Martin Schwerdtfeger Senior Economist, International Alistair Bentley Economist Chris Jones Economist TO REACH US Mailing Address King Street West 1st Floor, TD Tower Toronto, Ontario MK 1A Fax: (16) 9-6 This report is provided by TD Economics. It is for information purposes only and may not be appropriate for other purposes. The report does not provide material information about the business and affairs of TD Bank Group and the members of TD Economics are not spokespersons for TD Bank Group with respect to its business and affairs. The information contained in this report has been drawn from sources believed to be reliable, but is not guaranteed to be accurate or complete. The report contains economic analysis and views, including about future economic and fi nancial markets performance. These are based on certain assumptions and other factors, and are subject to inherent risks and uncertainties. The actual outcome may be materially different. The Toronto-Dominion Bank and its affi liates and related entities that comprise TD Bank Group are not liable for any errors or omissions in the information, analysis or views contained in this report, or for any loss or damage suffered. 7