Bank of Canada rate outlook
The structural issues with Canada’s miraculous economic growth coming out of the recession has been painfully obvious to me for some time now. When one strips away the economic spin-offs of rising home prices and the associated wealth effect spending, inventory restocking by businesses, and stimulus spending by government, we find our growth miracle was largely a mirage.
The unsustainability of this growth illusion should be clear to my readers. An economic bounce fueled by an expansion in already-stretched consumer credit and government spending is not the start of a protracted period of economic bliss. At best it temporarily papers over the structural weaknesses. At worst, it magnifies them.
Being fairly obvious to me, I went out on a limb and predicted several times that the BoC would not raise interest rates. This prediction was not made on the basis of what I thought the BoC should do, but rather what I anticipated Carney would do given the response of most central bankers, who seem to all play by the same rulebook. I was twice proven wrong earlier this year. My pride being battered, I take some solace in the fact that most economists are starting to see things my way.
If we rewind back to late 2009 and early 2010, at a time when I was predicting a long stretch of record low interest rates, the consensus among the big banks was that interest rates would hit 2% to 2.5% by early 2011.
Today we see that the ‘unexpected’ weakness in our economy has resulted in the big bank economists removing their rose-coloured glasses:
“…Observers are quietly resigned to the fact that on Tuesday central bank governor Mark Carney will hold rates as they are and will likely continue to do so for at least the next few months.
The broad conviction stems from a host of recent data showing the economy slowing to a crawl — most recently in terms of growth, now a paltry one per cent, and the labour market, which has been coughing out an average of 4,000 jobs a month, compared to a 75,000-a-month average earlier in the year.
“There is no disagreement that the bank will keep its overnight lending rate unchanged at 1.0 per cent as it chose to do in October following a string of three 25 basis point rate hikes this summer,” said BMO Capital Markets deputy chief economist Douglas Porter.”
That makes me feel at least somewhat vindicated. But where do things go from here? Well, we know that consumer credit must slow at some point. It is pushing 150% of disposable income, an all-time high. That part is indisputable. What the reversion back to the mean will look like is the only question.
My contention is that most people in a society overwhelmingly think as a collective. Once it becomes apparent to some that their consumption-driven lifestyle is in fact damaging to their long-term financial health, it will likely become obvious to many. I’d suggest that we are very near that epiphany moment.
When that moment is reached and people suddenly realize that they have too much debt and too little savings, the inevitable reversion will have some predictable consequences: It will constrict both consumer spending (+65% of GDP) and it will slow demand for housing. House prices will fall, which we know will choke off HELOC growth, which added over 8% to household income in the past year. The net result will be a marked slowing of Canada’s economy and a likely recession by late 2011 if my time line is correct.
It would take a central banker with extreme integrity and nerves of steel to raise rates in that environment. As much as I believe it is necessary for the long-term health of the country, I just don’t see it happening.
My prediction stands: We will again see emergency low interest rates before we see a serious round of rate hikes that brings us back to historical norms.
Consumer confidence in the dumps
Despite some recent month-over-month improvements, the overall reading in consumer confidence as measured by the Conference Board of Canada remains well below pre-recession levels….hardly indicative of a new phase of economic expansion.
The Conference Board data provides some predictive value in determining the future direction of consumer spending:
“As it did in each of the two previous months, the balance of opinion on major purchases worsened. Consumers are asked if they feel now is a good time to make a major purchase—such as a car, home, or major appliance. This month, 41.2 per cent responded that it was, a 0.2 point increase. Unfortunately, the share who said that it was a bad time rose even more—up 0.7 percentage points—to 48.6 per cent.”
A new poll by the Institute for Research on Public Policy may provide some insight into how consumer confidence and consumer perceptions may shape the political climate in the not-to-distant future. I have been arguing for some time now that austerity is coming to most of the Western world, Canada included. I have argued that it will either be forced on us or embraced by us. The recent unlikely victory by conservative leaning Rob Ford in the predominantly left-leaning Toronto tells volumes. Even more telling is the fact that Ford tapped into consumer anger using a campaign line of “Stop the Gravy Train”.
The new poll data has found that some measures of consumer confidence are back to the levels seen during the credit crisis of 2008.
“The Canada “right direction” number is 52.2 percent — almost identical to the 53.6 percent we found in 2008 — but that was in different economic circumstances following the crash of the stock market and the start of the worst synchronized global recession in 60 years.”
“While Canada has come out of the recession in better shape than any of its G7 partners, the weaker “right direction” numbers indicate a lack of confidence in the recovery and a growing malaise, despite six consecutive quarters of economic and employment growth.”
Perhaps people are sensing that the ‘growth’ is in fact illusory, backed overwhelmingly by an unsustainable run-up in credit.
I don’t often comment on politics, though I will chime in on this one. Of far more interest to political watchers is the implications of this reading for the Harper government in the next election. While I cannot prove it decisively, I will suggest that the discontent that the electorate feel with Stephen Harper is largely rooted in its own ‘conservative’ support base. The largest peace-time deficit has been spent to create a rapidly-fading economic bounce. Against this backdrop, it’s exceptionally difficult to label Harper a ‘conservative’. I think people are starting to get that.
There is a secular shift coming that will alter the way our society feels about consumption, credit, and what it means to have a ‘comfortable’ lifestyle. Our perception of entitlement programs will shift with it, as will the collective political leaning. True fiscal conservatives will reign. Mark my words. The only question is how close we are to that secular shift, and who will step up with the integrity to lead in that climate.
It certainly won’t be Mr. Harper.