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Why is the economy beating forecasts?

Feb. 14, 2011, Ottawa – The vast majority of economists see Canada experiencing modest growth this year, including in jobs.

Feb. 14, 2011, Ottawa – The vast majority of economists see Canada experiencing modest growth this year, including in jobs. But a few are willing to talk up the economy and believe Canadians will have a much better year than most think.

The economic story for this year appears chiselled in stone. Canada is slated for modest growth with no or only minor improvement in the unemployment rate. That’s the widely held view encompassing the International Monetary Fund, the Bank of Canada and the majority of private sector economists – but it’s not the universal opinion.

At a time of reflex caution, a few – the Royal Bank and Merrill Lynch Canada in particular – are sticking their necks out to make the case for a much stronger economy in the next few years. If true, it would change the prevailing assumptions on everything from jobs, interest rates to government deficits.

“Rose-coloured glasses or clearer vision?’’ Royal Bank economists recently asked of their top-of-class forecast that Canada’s gross domestic product will grow by a relatively robust 3.2 per cent this year. If it comes to pass, that would be good news for the unemployed since the RBC says it would translate into the creation of 324,000 jobs, about 100,000 more than many others think likely.
 
“When you have an outlier position you have a concern that maybe you are missing something,’’ RBC assistant chief economist Paul Ferley admits. (Editor’s note: "Outlier" is a scientific term to describe things or phenomena that lie outside normal experience.) But he is becoming more convinced of his analysis with each economic indicator, he says.

Earlier this month, Finance Minister Jim Flaherty revealed his department’s sampling of 15 forecasters found the average at 2.4 per cent, the setting of the Bank of Canada. Some were as low as 1.8 per cent.
Despite the gap, economists see the future unfolding pretty much in the same way. Canadian housing will slow, tapped out consumers will play a minor role in supporting output, and the public sector – government spending – will turn negative as stimulus is phased out.

Where the optimists diverge is in how much of a bounce exporters can expect from what is going to be a good year in the United States, given that the strong loonie historically dampens exports.

The optimists who say demand will trump price have come up aces in recent economic reports, especially December’s head-scratching 9.7 per cent pop in exports, the best monthly gain in 30 years.
Exports to the U.S., which would be most affected by the loonie, rose 10.8 per cent.

“This report would suggest there’s sufficient strength in the U.S. and elsewhere to support our trade (despite the dollar),’’ Ferley said.

The monthly numbers are perhaps exaggerated, but they didn’t completely surprise Ferley or Shirley King, chief economist at Merrill Lynch Canada, the other major forecasting house that sees Canadian growth north of three per cent this year, at 3.1.

Last month, the Bank of Canada upgraded U.S. growth in 2011 to 3.3 per cent, a full point more than its previous estimate, yet only bumped Canada up from 2.3 to 2.4 per cent. “The Bank of Canada does seem to think the Canadian dollar does have a very large headwind, and I agree we’re not going to see the type of export rebound we normally do,’’ King explained. “But it doesn’t really matter. If people are buying our stuff, the Canadian economy is going to benefit from it.’’

She notes that the last three months have seen over 100,000 jobs created in Canada, with over half showing the pull of the improving U.S. market, since they came from sectors such as resources, agriculture, manufacturing and transportation.

Peter Hall of Export Development Canada says his talks with industry leaders reveal nervousness about the loonie, but he notes there are reasons to believe exporters can thrive, including the pent-up demand in the U.S. auto and home sectors.

The trade numbers Friday may lead other forecasters to rethink the strength of the Canadian economy, although none so far have gone to where the RBC and Merrill Lynch have been.

The Bank of Montreal nudged its projections only one tick to 2.8 per cent, while the CIBC said it would raise it’s fourth quarter estimate “a few ticks” above the current 2.3. BMO’s Douglas Porter says the arrow is pointing toward the upside, however, and he agrees with the optimists that the consensus hasn’t factored in sufficient Canadian benefits from the U.S. recovery.

If the optimists prove correct – and the evidence will come in a matter of months – the Bank of Canada could be moving a lot earlier to raise interest rates than markets anticipate, possibly as soon as April.

Also, a stronger economy will have major implications for fiscal budgets, both federal and provincial, allowing governments to accelerate their timetable for eliminating deficits.