Economic Forecast: Canada To Do Better Than Expected, But Loonie Will Slide, RBC Says

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ECONOMIC FORECAST CANADA RBC
Canada's largest bank is forecasting the economy will do slightly better than most expect in the next two years, and one reason why is that the Canadian dollar won't. (Canadian Press photo) | CP

OTTAWA - Canada's largest bank is forecasting the economy will do slightly better than most expect in the next two years, and one reason why is that the Canadian dollar won't.

The Royal Bank (TSX:RY) is projecting growth rates of 1.8 per cent for 2013 and 2.9 per cent for 2014, which is a couple of decimal points better than the consensus estimate federal Finance Minister Jim Flaherty will be using in Thursday's budget.

But the bank says the Canadian dollar is unlikely to see sustained parity again over the next two years, averaging at about 96 cents US in 2013 and 98 cents US in 2014.

The loonie was down 0.17 of a cent at 97.65 cents US in early trading Tuesday.

"Previously, we had a firmer Canadian dollar outlook," the RBC economists say in a report released Tuesday.

"However, reduced Bank of Canada rate hike expectations, steady to lower commodity prices, and softening demand for Canadian financial assets are likely to result in Canada's currency trading below parity with the U.S. dollar for the forecast horizon (two years)."

While that's bad news for snowbirds and cross-border shoppers, the lower-flying loonie should do wonders for exporters and Canadian manufacturers, reducing the price of what Canadians ship abroad and raising the cost of imports.

The new numbers represents a climbdown for the private sector bank, which last year had expected the Canadian economy would be far stronger at this point.

RBC chief economist Craig Wright says 2012 was a very different year than what had been expected, starting off sluggishly and then continuing to weaken, producing the worst two-quarter growth rate in the second half of the year — averaging 0.7 per cent — since the end of the recession in 2009.

And this occurred despite the fact none of the doomsday scenarios, from a European collapse to the U.S. economy falling off the fiscal cliff, came to pass.

What's even more surprising is that while the economy slowed, hiring in Canada kept growing, churning out an above-consensus 310,000 jobs during the year.

"The assumption was that as we see consumer spending pull back, and housing pull back and government being neutral, the growth baton would be handed off to exports and business investment," he explained.

"(But) the economy doesn't seem to be transitioning as smoothly as was hoped for. I think a lot of it has to do with uncertainty and the impact that is having on businesses, more on the investment side than on the hiring side."

Meanwhile, exports haven't kept pace either, with the value of shipments remaining eight per cent below pre-recession levels.

The Bank of Canada has also put its growth eggs in the exports and investment basket. As such, the central bank has had to tamper down its expectations, and will likely need to drop its official forecast from the current two per cent once more next month, when it releases a new monetary policy review.

On Thursday, Flaherty is expected to announce he will base his budget calculations on a 1.6 per cent growth rate this year, the average of the forecasts he was given by the private sector economists earlier in the month.

The RBC said it believes the economy is in better shape than the bottom-line numbers suggest. Part of the reason most forecasts are so low is the weak hand-off from the end of 2012, which affects rates going forward. In essence, the speed bump in the second half of last year did not derail the economy's recovery but merely interrupted it.

As such, the bank said it believes the conditions needed to sustain the recovery's momentum — a U.S. and global recovery — remain in place. It sees growth picking up in each quarter this year, starting from 1.9 per cent almost completed first quarter, followed by 2.4, 2.9 and 3.0 in the subsequent three-month periods.

"Some of the factors that dampened activity in late 2012 have started to reverse," the report states, even if continued uncertainty over Europe and the U.S. will weigh on confidence early this year.

"Domestic financial conditions remain supportive, and as the downside, risks to these key economies dissipate, we expect both consumer and business spending to accelerate, although neither is likely to deliver the rapid gains recorded in the early days of the expansion."

One of the key drags will be the "mild correction" in housing activity, adds the report.

The year will also see fewer jobs created, the bank says, with expectations in the 200,000-250,000 range in both years, still enough to lower the unemployment rate below seven per cent by the end of 2013.

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