BUSINESS

Global malaise impacting Canada, as current account deficit expands

05/31/2012 09:00 EDT | Updated 07/31/2012 05:12 EDT
OTTAWA - Canada's economy is showing signs of succumbing to weakening global conditions as the country's total trade deficit widened in first quarter in the face of weaker external demand.

Statistics Canada reported Thursday the country's current account deficit widened by $600 million to $10.3 billion in the first quarter due to a smaller export surplus in goods and bigger deficit in services.

And analysts predict the gross domestic product report Friday will show the first quarter also disappointed with a sub-two per cent growth performance, well below the Bank of Canada's 2.5 per cent call.

Desjardins Securities economist Jimmy Jean is even gloomier, predicting growth of 1.5 per cent and with exports trouble looming for the second quarter as well.

The March current account deficit, which includes merchandise, services and investment activities with the rest of the world, was actually slightly better than predicted.

But economists note Canada appears to be making little headway in eliminating the overall deficit, which appeared during the recession and is now running at an annualized $41.1 billion, or 2.3 per cent of gross domestic product.

"Globally things are worsening meaningfully," said Benjamin Reitzes, a senior economist with BMO Capital Markets.

"We're still having trouble recovering from the great recession and until things pick up globally, the U.S and from a commodity perspective, it's going to be tough for Canada to pull out of this current account deficit."

The March gap was due to a smaller merchandise trade surplus, as previously reported, combined with a larger services deficit.

Thursday saw little to cheer about on the global front.

In the U.S., Canada's largest trading partner, the Labour Department reported weekly applications for unemployment benefits rose for the fourth straight time. Meanwhile, a private-sector survey showed hiring in May added a mere 133,000 jobs.

Also Thursday, the U.S. Commerce Department said the U.S. economy's growth rate in the first quarter was only 1.9 per cent, not the 2.2 per cent initially reported.

Canada announces its first-quarter report on gross domestic product on Friday and economists are almost united that the Bank of Canada forecast of a 2.5 per cent boost will not be met. The consensus is for a 1.9 per cent increase, matching the modest expansion in the U.S., with some projecting an even worse quarter.

"Looking ahead, the current account deficit could widen further in the second quarter on a weaker trade picture, and we have already seen the sentiment shift in Q2 as uncertainty about Europe increases flight-to-safety flows," said TD Bank economist Leslie Preston.

Analysts say that Europe remains the wild card.

The Bank of Canada has long considered it the biggest risk to the global recovery, although it recently downgraded the situation from crisis to chronic.

That view has likely changed, however, and may be reflected in the central bank's upcoming interest rate statement on Tuesday. Greece appears to be lurching toward insolvency and a possible exit from the euro, while attention has now turned to Spain's under-capitalized banking sector.

Of the two, RBC's chief European economist Jens Larsen said Canadians should be most concerned with Spain, warning trouble in Europe has the potential to knock the global recovery off it's axis. Canada won't be spared, said Larsen.

"I find it difficult to imagine that you have a very bad outcome in Europe and not have a material impact globally," he said. "At the moment you see uncertainty is having an impact on the willingness to invest in Europe, (so) it's not difficult to imagine the circumstances in which it turns into something much worse."

He compared the current situation to before the Lehman Brothers failure in the fall of 2008. If Europe touches off a similar financial crisis, the global economy and Canada's would be sideswiped by a collapse in confidence, investment and trade, he said.

In a far from rosy assessment, European Central Bank head Mario Draghi warned EU leaders in Brussels that the current operating framework of the 17-country currency union was unsustainable.

And he said national regulators are making the situation worse by not coming clean about the state of the banking sector in troubled countries, citing the recent bailout of Bankia in Spain, and before that Dexia in Belgium.

"What Dexia shows — and Bankia shows as well — is that whenever we are confronted with the dramatic need to recapitalize, if you look back, the reaction of the national supervisors... is to underestimate the problem, then come out with a first assessment, a second, a third, fourth," he said.

"That is the worst possible way of doing things, because everybody ends up doing the right thing but at the highest possible cost and price."

Finance Minister Jim Flaherty has been vocal in calling on European authorities to "overwhelm" the problem with a massive bailout — as the U.S. did in 2008 — rather than try to put out fires as they appear piecemeal.