POLITICS

Fed boost likely to lift Canadian economy also, but weak fundamentals remain

09/10/2012 04:15 EDT | Updated 11/10/2012 05:12 EST
OTTAWA - Canada's struggling economy will likely get an indirect nudge, albeit a tiny one, from stimulus measures being adopted and contemplated in major world economies, economists say.

With the U.S. Federal Reserve looking like it's preparing to follow its European counterpart's lead by introducing so-called QE-3 on Thursday, and China likely to join in later this fall, stimulus is still the name of the game three years into the stuttering recovery.

That's startling, especially since massive amounts of fiscal stimulus that have sapped many a nation's reserves and years of super-low borrowing rates are barely producing two per cent growth in Canada and U.S.

"It's a reflection of the times. It tells us the enormous challenge the global economy is still facing," said TD Bank chief economist Craig Alexander.

"The thing I find remarkable is that financial markets keep expecting central banks to ride to the rescue and save them. But the reality is that central banks really can't — they can provide support but they can't deal with the root problems."

Still, when governments are cutting back on spending in an effort to rebalance their books, and companies are still largely sitting on what Bank of Canada governor Mark Carney calls "dead money" because of the very real fears of another slump, somebody has to do something to prime the pump.

Though details are scarce, Fed chairman Ben Bernanke has signalled he will do his part later this week through a third round of quantitative easing by buying up risk to free up more money.

He may move directly to revive America's bottom-dragging housing market with a scheme to buy up mortgage-backed securities, or other forms of asset purchases. He will also almost certainly push back his advisory on when interest rates are to start rising to sometime in 2015.

Global markets, which reacted well to the European Central Bank's pledge to buy up sovereign bonds last week, are clearly counting on the Fed doing its part this week.

Equity markets and commodities have firmed and the Canadian dollar continues to advance as risk declines. The loonie hit a fresh one-year high water mark Monday, climbing one-fifth of a cent in inter-day trading to 102.43 cents US.

The impact on Canada will be small but positive, says Royal Bank chief economist Craig Wright, who Monday predicted the economy would enjoy a better second half than first.

Growth in Canada came in at a disappointing 1.8 per cent both in the first and second quarters, but RBC is calling for the third and fourth to produce rates of 2.4 and 2.6 respectively. That would push growth to slightly over two per cent for the year, solid if not stellar.

"With the ECB actions last week ... we should see the odds of the worst case scenario declining," Wright said.

The Fed action, if it comes, will also produce some positive sentiment even if the argument for its effectiveness remains sketchy, said economists.

Scotiabank's Derek Holt echoed the doubts in his note to clients: "I'm more comfortable with what I think the Fed will do than what it should do and how at this juncture," he said, listing the probability of a QE-3 announcement this week at 60 per cent.

The benefit to Canada is that anything that helps the U.S. economy helps Canada, given that it's our largest trading partner.

As the data shows, Canada's snail-paced recovery is chiefly attributed to the weakness of its exporting sector, particularly shipments to the U.S.

QE-3 may not boost the U.S. economy significantly, economists say, but it's better than the alternative — the Fed doing nothing and disappointing already-jittery markets. Like the ECB, the Fed is tasked with preventing the bottom from falling out.

"I think the ECB bought the political system time last week," explained Alexander.

"Even though I do not think it will boost growth or job creation meaningfully, the Fed could also provide some short-term boost, even if in a relatively limited way."

The real-world impacts could be to raise business and consumer confidence, boosting investments and household spending. As well, a positive market reaction would give a lift to global commodity prices, which as Carney said last week, are an "unambiguous" good for the Canadian economy.

Lastly, Alexander said more monetary stimulus could lower bond yields in the U.S. and indirectly in Canada, and that means lower borrowing costs in both economies.

But don't expect any lasting benefits, said analysts. After the initial rush, economies and markets will again return to levels that reflect the fact that fundamentally little has changed. In many countries, both governments and households will need time to undo the damage of years of feckless borrowing and spending.

"History tells us financial excess is usually followed by financial stress," said Wright. "We had a decade of financial excess, so we have a decade of stress left, and we're only half-way through it."