ECONOMIC FORECAST UPDATE

Transcription

1 ECONOMIC FORECAST UPDATE TD Economics Canada not Immune to Brexit Impacts Highlights Over the past week, a number of clients have reached out inquiring about the potential impact to the Canadian and U.S. economies in the wake of the UK referendum to exit the EU. As we ve remarked previously, in a low growth, low interest rate environment, the global economy has less cushion to absorb downside risks emanating from the data and political events. This leaves financial markets more susceptible to bouts of volatility or mini-cycles as political events unfold. We took a rigorous approach to looking at the downstream impacts to the Canadian and U.S. economies and applied reasonably conservative assumptions. In doing so, there is some reassurance that both economies should remain resilient, with the most likely channels of weaker growth coming through exports and business investment, and some offsetting influences via households. The annual growth forecasts were only downgraded by 0.1 percentage points for Canada in 2016 and 2017 to 1.2% and 1.9%, respectively. This embeds a 0.4 percentage point (annualized) hit in the second half of this year. The global adjustment to a weaker UK and more fragile European Union is expected to culminate in world growth of 2.9% in 2016 and 3.2% in 2017 (down from 3.4% previously) Brexit only serves to reinforce our resolve that the Bank of Canada will leave its overnight rate unchanged at 0.50% until at least TD Economics June Quarterly Economic Forecast (QEF) was based on the assumption that although the UK referendum vote was bound to be close, ultimately voters would choose to remain within the European Union. These forecasts must now be re-evaluated in light of the majority of votes favouring to exit the union. Many questions remain unanswered; important among these is when the UK government will invoke Article 50 to begin the negotiation process towards the union exit and what those negotiations will ultimately bring with regards to new economic and political terms. However, one thing is certain. We have moved into yet another period of elevated economic and market uncertainty within a vulnerable global environment encompassed by a low growth, low interest rate environment, and Canada is no exception. This has led us to downgrade the outlook for business investment, exports, and, to a lesser extent, employment. On net, annualized growth in the second half of this year was reduced by 0.4 percentage points, though the impact on the full year forecast is likely to be small (1.2% versus 1.3% in the June QEF). As some of this increased caution will have some staying power, next year s growth projection has also been pared back slightly, from 2.0% to 1.9%. From the Bank of Canada s perspective, the economic impacts of Brexit are not likely to be large enough to precipitate a policy reaction. Rather, it reaffirms the view that Governor Poloz will want to keep his foot on the accelerator for as long as possible, maintaining the Bank s policy interest rate at 0.50% well into Beata Caranci, VP & Chief Economist, Derek Burleton, VP & Deputy Chief Economist, Brian DePratto, Economist,

2 Biggest impacts on Canada to come via indirect channels As discussed in our initial Brexit analysis, Canada has relatively limited direct trade linkages with the U.K., with more significant links via direct investment. As a result, we expect the bulk of the Brexit impact to occur largely through indirect impacts, in particular through business and consumer confidence, as well as through the U.S. (where impacts are also largely occurring indirectly). Indeed, in the days immediately following the vote, market volatility rose markedly as risk aversion took hold. The situation has since calmed, but on a forward-looking basis, we expect to see further bouts of volatility as events in Europe unfold, alongside a downgraded European economic outlook. Abstracting from the volatility, exchange rates, interest rates, and oil prices are expected to evolve broadly in line with our previous expectations, although the Federal Reserve is now expected to begin raising rates only in March 2017 (rather than September of this year). This change in expectation would typically be associated with upward pressure on the loonie, but safe haven financial flows stemming from Brexit will counteract this pressure. The key transmission channels and their likely impacts are laid out in Table 1. While not all channels are growthnegative for Canada, on balance we expect the shocks to be growth-negative for the coming quarters. A key direct negative channel is foreign activity. As our research has shown, relative to the past, measures of foreign activity play a more important role in the outlook for Canadian exports, while currency changes play a lesser role. U.S. business investment, a key component to our measure of foreign activity, is now expected to be weaker, reducing demand for Canadian exports. With a strong U.S. dollar, American exports are also expected to be weaker, further impacting Canadian exporters via supply chain impacts. An unchanged exchange rate outlook means that there will be no additional price movement (relative to our previous forecast) to offset these impacts. Weaker business confidence is not limited to the U.S., but will also impact Canadian firms. With a rise in global uncertainty, this may embed a greater degree of wait and see investment behaviour among firms. Accordingly, while we continue to see a recovery in Canadian business investment in 2017, the pace of growth will be weaker than previously expected. Moreover, the recovery is not expected to occur until the latter half of the year, as decision-makers hold off on spending decisions until more clarity is available. This uncertainty will also weigh on hiring, but the size of the change is not sufficient to meaningfully impact consumer spending. Similarly, with interest rates expected to evolve largely in line with our previous forecast, there are no major changes to our outlook for residential investment. Rising table 1. Key transmission Channels for Canadian Brexit Impacts Channel economic Impact details Exchange Rate Neutral As the U.S. dollar receives the bulk of 'flight to safety' flows, it is expected to continue strengthening, including against the loonie. However, this dynamic of a weakening loonie was already built into our export profile and does not materially change our forecast based on improved competitive position. Foreign Activity Negative Global uncertainty and a higher U.S. dollar will both weigh on domestic activity south of the border, particularly business investment. This reduces demand for Canadian exports. Interest Rates Positive Lower government yields + increased likelihood that central banks will maintain accommodative monetary policy for even longer to help offset the uncertainty impacts. Confidence Negative Heightened uncertainty likely to give firms pause in investment plans, with the potential to push back the resumption of business investment even further. Oil Prices Neutral Oil price forecast unchanged, but risks are tilted towards lower global oil prices on a combination of higher U.S. dollar and reduced global growth expectations. Weaker oil prices present some downside risk to Canadian investment, but as we were not expecting oil to be a driver of investment, absent a significant drop in oil prices, impact should be limited. overall negative although there are some factors that offer some potentially offsetting counterweights for the economy, they are not significant enough in size to offset the negative confidence and foreign activity impacts. Source: TD Economics 2

3 FIGure 1. BrexIt to WeIGH on near-term GroWtH Real GDP, Q/Q % Chg, SAAR. Forecast 2016Q1 2016Q3 2017Q1 2017Q3 Source: Statistics Canada, TD Economics Previous Forecast Incorporating Brexit Difference borrowing costs and stretched affordability are likely to lead to an eventual pull-back in activity. However, with strong momentum in this sector at present, this adjustment is not likely to be seen until the second half of As shown in Figure 1, the economic impacts of Brexit are likely to be largest in the near-term. Uncertainty should eventually be reduced, and a slight boost to growth is expected as pentup demand is released, particularly for investment among non-commodity firms. Growth in the second half of 2016 is expected to average 2.3% at annual rates, a 0.4 percentage point reduction relative to our previous forecast. As 2017 progresses, however, a modestly higher pace of growth is expected. The net impact is growth of 1.2% this year (previously 1.3%), with the 2017 output acceleration slightly more muted than before: 2017 growth was expected to reach 2.0%, in part related to the feedthrough of past government stimulus initiatives to infrastructure; Brexit will trim this to 1.9%. Looking beyond the impact on economic growth, Brexit is unlikely to make much of a mark on inflation. The weaker near-term economic outlook will reduce underlying inflationary pressures, but only at the margin. The expected depreciation of the Canadian dollar will place some upward pressure on inflation via imported prices. However, this effect was already included in our previous forecast. With safe haven flows counteracting the delay in Federal Reserve tightening, the exchange rate profile, and thus the inflation outlook is left effectively unchanged. Headline inflation is expected to pick-up somewhat, but remain in line with the Bank of Canada s 2% target. Bank of Canada on hold indefinitely Unlike the Federal Reserve, the domestic economic fundamentals had already placed the Bank of Canada in a holding pattern ahead of the Brexit referendum. As a result, the uncertainty created by Brexit will only serve to reinforce our resolve that the Bank will leave interest rates unchanged until On this front, TD Economics had already maintained a more conservative view than a number of our peers. Keeping policy accommodative for longer will help maintain lower longer-term yields, which will also be pushed lower by a falling global yield environment. Slightly lower longer term yields will provide some economic stimulus, but we have applied conservative estimates to this economic impact due to the corresponding elevated uncertainty, persistently high household indebtedness and our belief in diminishing returns to lower borrowing costs. Bottom Line While it is still early days, the shock of Brexit has already reverberated through global markets. With time, it will make itself felt in economic output as well. Canada will not be immune. However, the economic impact of Brexit should only be a temporary setback for the Canadian economy. Although somewhat insulated from strong direct impacts, the influence of a more uncertain world on confidence alongside indirect effects will be sufficient to reduce second half growth by roughly 0.4 percentage points this year, pulling 2016 and 2017 annual growth rates slightly lower. With an unchanged outlook for the loonie and only modest growth impacts, we have not changed our outlook for inflation, meaning that the Bank of Canada will be focused on underlying demand fundamentals. We do not expect the economy to weaken sufficiently to prompt a cate cut. Rather, the Bank of Canada is likely to keep the policy interest rate at 0.50% into However, the Bank is certainly walking on a tight rope, as Brexit is adding to an already long list of headwinds for Canadian growth that include the impacts of the Alberta wildfires (yet to be felt in the data), and an ongoing economic adjustment to lower commodity prices. 3

4 CanadIan economic outlook: Period-Over-Period Annualized Per Cent Change Unless Otherwise Indicated Q1 Q2 Q3 Q4 Q1 Q2F Q3F Q4F Q1F Q2F Q3F Q4F 15 16F 17F 15 16F 17F real Gdp Consumer expenditure Durable Goods non-res. Fixed Investment Non-Res. Structures Equipment & IPP* residential Investment Government expenditure Final domestic demand exports Imports Change in non-farm Inventories ($2007 Bn) Final sales International Current account Balance ($Bn) % of GDP pre-tax Corp. profits % of GDP Gdp deflator (Y/Y) nominal Gdp Labour Force employment employment ('000s) unemployment rate (%) personal disp. Income pers. saving rate (%) Cons. price Index (Y/Y) Core CpI (Y/Y) Housing starts ('000s) productivity: real Gdp / worker (Y/Y) *Intellectual Property Products. F: Forecast by TD Economics as at June annual average Sources: Statistics Canada, Bank of Canada, Canada Mortgage and Housing Corporation, Haver Analytics. 4th Qtr/4th Qtr 4

5 u.s. economic outlook: Period-Over-Period Annualized Per Cent Change Unless Otherwise Indicated annual average 4th Qtr/4th Qtr Q1 Q2 Q3 Q4 Q1 Q2F Q3F Q4F Q1F Q2F Q3F Q4F 15 16F 17F 15 16F 17F real Gdp Consumer expenditure Durable Goods non-res. Fixed Investment Non-Res. Structures Equipment & IPP* residential Construction Govt. Consumption & Gross Investment Final domestic demand exports Imports Change in private Inventories Final sales International Current account Balance ($Bn) % of GDP pre-tax Corporate profits including IVa&CCa % of GDP Gdp deflator (Y/Y) nominal Gdp Labor Force employment Change in empl. ('000s) ,893 2,359 1,634 2,775 1,989 1,543 unemployment rate (%) personal disp. Income pers. saving rate (%) Cons. price Index (Y/Y) Core CpI (Y/Y) Core pce price index (Y/Y) Housing starts (mns) real output per hour (y/y)** *Intellectual proprty products. **Non-farm business sector. F: Forecast updated by TD Economics, Source: U.S. Bureau of Labor Statistics, U.S. Bureau of Economic Analysis, TD Economics 5

6 Interest rate outlook Q1 Q2 Q3 Q4 Q1 Q2* Q3F Q4F Q1F Q2F Q3F Q4F Canada Overnight Target Rate mth T-Bill Rate yr Govt. Bond Yield yr Govt. Bond Yield yr Govt. Bond Yield yr Govt. Bond Yield yr-2-yr Govt Spread u.s. Fed Funds Target Rate mth T-Bill Rate yr Govt. Bond Yield yr Govt. Bond Yield yr Govt. Bond Yield yr Govt. Bond Yield yr-2-yr Govt Spread Canada - u.s spreads Can - U.S. T-Bill Spread Can - U.S. 10-Year Bond Spread F: Forecast by TD Bank Group as at June 2016; All forecasts are end-of-period; Source: Bloomberg, Bank of Canada, Federal Reserve. *Spot rate on June 29, ForeIGn exchange outlook Currency exchange rate Q1 Q2 Q3 Q4 Q1 Q2* Q3F Q4F Q1F Q2F Q3F Q4F exchange rate to u.s. dollar Japanese yen JPY per USD Euro USD per EUR U.K. pound USD per GBP exchange rate to Canadian dollar U.S. dollar USD per CAD Japanese yen JPY per CAD Euro CAD per EUR U.K. pound CAD per GBP F: Forecast by TD Bank Group as at June *Spot rate on June 29, All forecasts are end-of-period. Source: Federal Reserve, Bloomberg, TDBG. CommodItY price outlook Q1 Q2 Q3 Q4 Q1 Q2e Q3F Q4F Q1F Q2F Q3F Q4F Crude Oil (WTI, $US/bbl) Natural Gas ($US/MMBtu) Gold ($US/troy oz.) Silver (US$/troy oz.) Copper (cents/lb) Nickel (US$/lb) Aluminum (cents/lb) Wheat ($US/bu) F: Forecast by TD Bank Group as at June E: Estimate. All forecasts are period averages. Source: Bloomberg, USDA (Haver). 6

7 GLoBaL economic outlook Annual per cent change unless otherwise indicated 2014 share* Forecast real Gdp (%) World north america United States Canada Mexico european union (eu-28) Eurozone (EU-19) Germany France Italy United Kingdom EU accession members asia Japan Asian NIC's Hong Kong Korea Singapore Taiwan Russia Australia & New Zealand Developing Asia ASEAN China India** Central/south america Brazil other developing other advanced *Share of world GDP on a purchasing-power-parity (PPP) basis. Forecast as at. **Forecast for India refers to fiscal year. Source: IMF, TD Economics. economic IndICators: G-7 and europe Forecast real Gdp (annual per cent change) G-7 (31.9%)* U.S Japan Eurozone Germany France Italy United Kingdom Canada Consumer price Index (annual per cent change) G U.S Japan Eurozone Germany France Italy United Kingdom Canada unemployment rate (per cent annual averages) U.S Japan Eurozone Germany France Italy United Kingdom Canada *Share of 2014 world gross domestic product (GDP) at PPP. Forecast as at Source: National statistics agencies, TD Economics This report is provided by TD Economics. It is for informational and educational purposes only as of the date of writing, and may not be appropriate for other purposes. The views and opinions expressed may change at any time based on market or other conditions and may not come to pass. This material is not intended to be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice. 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. This report contains economic analysis and views, including about future economic and financial 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 affiliates and related entities that comprise the 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