TD Economics Monetary Policy Monitor September 8, 9 www.td.com/economics HIGHLIGHTS The Canadian economy appears to have passed the worst of the slump. And while growth is on the horizon, the general dichotomy in economic drivers remains a theme. Domestic growth remains steady while exports continue to hobble along. By most measures, credit markets continue to stage a recovery. The overall strength of the currency continues to present a brake to both growth and central bank action. Given the Bank of Canada s conditional commitment to keeping rates steady through the second quarter of, there may only be few and modest changes to the statement. The Bank might tinker with the wording of the risk assessment, but maintain that the currency still has the potential to unwind the positive steps made in the economy. But given the improvement in credit conditions, the issue of quantitative easing is pretty much off the radar. This will not stop the BoC from reiterating its considerable flexibility with regard to the conduct of monetary policy. On the Road to Recovery The economic landscape in Canada continues to improve slowly and the data since the last FAD meeting on July corroborate this view. It is clear the worst of the recession has past, an in fact the Bank of Canada declared the recession to be over just after the July FAD. But even so, there remains an important divergence in the economy s growth drivers, which suggest that the turnaround in the economy will take time before it returns to full potential. The external sector continues to show signs of stress, while the domestic sector remains buoyant. But even with this ongoing theme in the Canadian economy, the broad brush strokes of the outlook have improved sufficiently to sug- - - - -8 Q/Q % Chg. Annualized REAL GDP 7 8 9 Source: Statistics Canada. gest a positive third quarter GDP result, but not sufficiently changed as to suggest the Bank of Canada will revise its policy stance. Nowhere has the dichotomy in Canadian growth been more obvious than in the second quarter GDP data. The.% Q/Q annualized contraction was more or less in line with the Bank of Canada s expectation. But the details of the data revealed some interesting trends. First, final domestic demand managed to eke out its first quarterly gain since the third quarter of 8. And there was an impressive.8% Q/Q, annualized gain in personal expenditures. This is the largest quarterly gain since the first quarter of 8. Moreover, the.% Q/Q, annualized gain in residential investment is a nod to the efficacy of the government s house-friendly tax credits, as well as improved affordability through a combination of attractive prices and mortgage rates. However, net exports were the big drag in the second quarter and explain much of the contraction. Net trade subtracted. percentage points from annualized GDP growth in the second quarter, which is the largest drag since December 7. The 9.% Q/Q, annualized contraction Monetary Policy Monitor September 8, 9
was significant, but not as impressive as the.% Q/Q, annualized decline in the first quarter. The Canadian dollar remains a millstone on the export sector, as it remains a key beneficiary of the U.S. dollar s broad adjustment, which is a theme that is likely to be played out for the next several months. Though with signs that the U.S. economy is coming back to life, there is some hope that Canada s export sector will see better times in the near future, especially as U.S. durable goods demand improves. Looking ahead, there is a good start to third quarter growth. June GDP posted its first increase since July 8. The.% M/M advance in GDP underscores a decent handoff to the third quarter. Credit markets never experienced the kind of turmoil that they did in the U.S., and are currently lending a good deal of support for domestic consumption. In particular, the housing market appears to have some good momentum. Not only will housing contribute to GDP, but so too will consumption. Both will be important drivers to underpin a positive result for the first time since late 8. Looking past the very near term, however, there is clearly a lot of slack in the Canadian economy. This suggests few price pressures in the Canadian economy. Canadian CPI data confirm a downward trend as headline inflation slipped by.% M/M. On an annual basis, headline inflation is at -.9% Y/Y, putting it at its lowest annual rate since 9. Considering the % Y/Y trend decline in energy over the last year, it is not surprising to see annual headline inflation at these multi-decade lows. But looking past the headline number, core inflation has been surprisingly sticky. In July, core inflation was.8% - - - Y/Y % Chg. AVERAGE RESIDENTIAL PRICE 7 8 9 Source: Canadian Real Estate Association. Inflation Measures Product Markets Labour Markets Wages & Costs Real Estate Inflation Expectations INDICATORS OF CAPACITY & INFLATION Policy Signal** ** Indicates suggested direction of overnight target rate Source: TD Economics.8.... -. -. -. -.8 -. M/M % Chg. EMPLOYMENT 7 8 9 Source: Statistics Canada. Y/Y. However, the output gap remains a potential source of moderation in core prices going forward. In addition, the continued rally in the Canadian dollar also argues for lower import prices. So the result in the coming months should be further moderation in inflation. In the labour market, there is scant evidence of price pressures, despite the surprising improvement in August when the Canadian economy added 7.K jobs. Since January, the economy has lost a total of.k jobs and the unemployment rate is now at a cyclical high of 8.7%, so there is evidence of underlying weakness in the labour market which will limit workers ability to negotiate wages. The developing slack in the labour market is apparent in the slowing in the pace of wage pressures. In August, average hourly wages were up.% Y/Y, which is well off the peak of.9% Y/Y in Q 8. Given that the labour market is a lagging indicator, there is little to suggest that wage growth will become pressing anytime soon. Such muted price dynamics support the BoC s case to keep rates steady at.%. The Bank of Canada has made a conditional commitment to keeping rates steady until the Monetary Policy Monitor September 8, 9
end of the second quarter of and there is still a body of evidence to support that case. As such, we expect no change to monetary policy for quite some time. Carney s Currency Considerations The strength of the Canadian dollar continues to grab headlines, despite the fact that pace of appreciation has slowed vis-à-vis the US dollar since the last FAD. Nevertheless, the relative strength of the Canadian dollar continues to be a much discussed topic and as such, the issue of currency intervention remains a hot one, especially if CAD takes charge at parity. A recent speech by BoC Deputy Governor Lane noted that the stronger Canadian dollar will dampen any economic recovery in Canada. He also reiterated that the Bank retains considerable flexibility through the use of unconventional monetary policy instruments, including quantitative easing. Clearly the notion of using alternative policy tools is still on the minds of BoC officials. But ultimately, the likelihood of currency intervention remains low for a number of reasons. First, a lot depends on what kinds of factors are driving the currency s rise. If, in fact, the Bank thinks that the Canadian dollar is appreciating due to fundamentals (ie. a Type I appreciation), the Bank would not react. The only way in which the Bank would likely react is if there was a sharp move higher. But even so, one has to consider that currency intervention is unlikely to achieve the desired result, which is to push the currency lower. Intervention s efficacy tends to be short lived. To make meaningful inroads with regard to currency intervention, the Bank would have to have some sort of policy follow-though which would imply an expansion of the Bank s balance sheet. In short, they would also need to undertake quantitative easing. However, the bar for such an undertaking appears to have been set quite high. So if the Bank of Canada were to embark on a quantitative easing path, the entire landscape would have to significantly deteriorate. The loonie continues to hover around U.S..9, and can in part be explained by the broad improvement in risk appetite and the coincident correction in the U.S dollar. Moreover, as global growth continues to gain traction, the commodity cycle may resume, which also underpins support for the Canadian dollar. In short, there are fundamental reasons for the loonie s rise. - - - CURRENT ACCOUNT BALANCE Billions of Dollars, Seasonally Adjusted 7 8 9 Source: Statistics Canada. We still expect the loonie to trade at parity with the U.S. dollar by year end. However, the issue is both the speed of appreciation as well as the level of the currency. In the unlikely event that the Canadian dollar moves much past that, there would be a renewed fervour for currency intervention. Nevertheless, the Canadian dollar is unlikely to warrant significant new verbiage in the statement. In the BoC s last communiqué, the Bank acknowledged that the higher Canadian dollar, as well as ongoing restructuring in key industrial sectors, is significantly moderating the pace of overall growth. The Bank might not sway too far from that statement. On Cruise Control For a While Yet The fact that the major economic data has largely evolved in line with the Bank of Canada s forecasts suggests the Monetary Policy Committee is likely to reiterate its conditional statement to keep the overnight rate at.% until the end of the second quarter of. That is fully priced in by the market as there really is nowhere else to go with regard to the overnight rate. And with no expected change to the overnight rate, all the focus will be on the nuances in the statement. It is likely to be very similar to the July statement. Neither the Bank s broad macro economic assessment nor inflation profile is likely to change in this statement. Headline inflation has been moderating, but that is already pencilled into the Bank of Canada s forecast as their third quarter CPI forecast is -.7% Y/Y. By the second quarter of, the Bank of Canada expects inflation to return to Monetary Policy Monitor September 8, 9
the % target and for the economy to return to full capacity. Thus, the Bank is unlikely to revise its wording on its inflation bias. In the July FAD the Bank noted that the overall risks to its inflation projection are tilted slightly to the downside. We expect virtually no change on that front. With ultimately little change to the economic outlook or expectations for future moves by the Bank of Canada, there is still the matter of whether the Bank maintains its trap door, should conditions deteriorate. Therefore, the statement that the Bank retains considerable flexibility in the conduct of monetary policy at low interest rates may remain a feature of the statement, though at this point, the statement remains more of a formality as the odds of having to employ such policy flexibility continues to decrease. Ultimately, if the economy unfolds as expected, the Bank of Canada has little reason to change its stance that the overnight rate will remain at.% until the end of the second quarter of. In the time between now and then, the Bank must figure out how quickly it must take away the punchbowl before the good times of low rates give way to a hangover. Charmaine Buskas Senior Economics Strategist TD Securities -98-97 Monetary Policy Monitor September 8, 9
INFLATION MEASURES CANADIAN CONSUMER PRICE INDEX (CPI) CPI: All Items CANADIAN GROSS DOMESTIC PRODUCT (GDP) AND PERSONAL CONSUMPTION DEFLATORS Personal Consumption Deflator - - Midpoint of Bank of Canada's Target Band Bank of Canada Core CPI ex. 8 most volatile items & indirect taxes Jan- Jul- Jan-7 Jul-7 Jan-8 Jul-8 Jan-9 Jul-9 Last plotted: August 9; Source: Statistics Canada/Haver - - - GDP Deflator - 9 9 9 9 9 9 9 97 98 99 7 8 9 Last plotted: Q-9; Source: Statistics Canada/Haver Analytics - - PRODUCT MARKET - - - - - - % CANADA'S OUTPUT GAP Actual Real GDP Less Potential Real GDP Full Capacity Excess Supply Excess Demand Actual data to Q-9 Forecast 9 9 9 9 9 97 98 99 7 8 9 Forecast by TD Economics as at June 9; Source: Statistics Canada, Bank of Canada 88 8 8 8 8 78 7 7 7 7 8 CANADIAN CAPACITY UTILIZATION RATE AND UNFILLED ORDERS-TO-SHIPMENTS RATIO* Ratio Capacity Utilization Rate (left scale) Unfilled Orders-to-Shipments Ratio (right scale) 9 9 9 9 97 98 99 7 8 9 * Total industry excluding aerospace products and parts Last plotted: Q-9; Source: Statistics Canada/Haver Analytics..9.8.7... LABOUR MARKET CANADIAN EMPLOYMENT AND UNEMPLOYMENT RATES Employment (left scale) - Unemployment Rate - (right scale) - 9 9 9 9 9 9 97 98 99 7 8 9 Last plotted: August 9; Source: Statistics Canada/Haver Analytics 9 8 7 SKILLED LABOUR SHORTAGE IN CANADA of firms 7 99 7 8 9 Last quarter plotted: Q-9; Source: Bank of Canada/Haver Analytics Monetary Policy Monitor September 8, 9
WAGES, COSTS AND REAL ESTATE AVERAGE HOURLY EARNINGS OF PERMANENT EMPLOYEES 8 - - CANADIAN UNIT LABOUR COSTS 98 99 7 8 9 Last plotted: August 9; Source: Statistics Canada/Haver Analytics - 9 9 9 9 9 9 9 97 98 99 7 8 9 Last plotted: Q-9; Source: Statistics Canada/Haver Analytics BANK OF CANADA COMMODITY PRICE INDEXES HOUSING PRICE INDEXES - - - - - - Total excl. energy Total 9 9 97 98 99 7 8 9 - - - - - - Resale New - - - 9 9 9 9 97 98 99 7 8 9 - - - Last plotted: August 9; Source: Bank of Canada/Haver Analytics Source: CREA, Statistics Canada; Last plotted: August 9 INFLATION EXPECTATIONS 9 8 7 INFLATION EXPECTATIONS - CANADIAN FIRMS % of firms expecting inflation to be above % % of firms expecting inflation to be -% 7 8 9 Last actual: Q-9; Source: Bank of Canada CANADIAN LONG-TERM GOVERNMENT BOND YIELD - CONVENTIONAL MINUS REAL RETURN 9 9 9 9 97 98 99 7 8 9 Source: Haver Analytics; Last plotted: August 9 Monetary Policy Monitor September 8, 9
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