Geopolitical risks to weigh on Canada’s growth

TORONTO Canada’s economy is expected to grow at a modest pace this year and over the next two years, but it will be in an environment “riddled with risks” from ongoing geopolitical and trade frictions, says a new report from Deloitte Canada.

Economic activity will expand at 1.5 per cent in the second half of the year and 1.6 per cent in all of 2019, according to the advisory firm’s chief economist Craig Alexander.

Growth will tick up to 1.7 per cent in 2020 and 2021 as lower interest rates shore up sluggish demand.

However, as the U.s.-china trade dispute intensifies and the chances of a chaotic Brexit persist, political events well beyond the Canadian government’s control could threaten those moderate gains.

“If there’s a trigger to the turn in the Canadian business cycle, it’ll actually originate from outside Canada,” Alexander said.

“There is vulnerability inside Canada in terms of elevated home prices and high levels of household debt, but there’s no real trigger. The challenge would be if China has a hard landing, if Europe goes into recession. If the world economy stumbles, then Canada will import the weakness from abroad...”

Canada’s economy grew at 1.8 per cent in 2018, down from a three-per-cent expansion in 2017.

After stalling for two consecutive quarters, Canada’s economic activity increased by a stellar 3.7 per cent in the second quarter of this year.

But the details of that blockbuster gain paint a far less impressive picture, said Alexander.

Consumption grew at just 0.5 per cent, its slowest pace in seven years and business capital spending slumped, with investments in machinery and equipment falling 32 per cent. Net trade alone, the factor most vulnerable to global events, was responsible for the gain in activity, as exports surged 13 per cent on rebounding shipments in agricultural products, crude oil and chemicals.

Imports fell four per cent.

“If strength in the second quarter came from trade, but trade is vulnerable to weakness in the global economy, well the outlook is a lot weaker,” Alexander said.

Global economic expansion continued to slow in the third quarter as many Asian and European manufacturing indexes contracted.

The U.S. indexes, which had been resilient, weakened during the summer with the highly regarded ISM manufacturing index dropping below 50 points, the threshold considered indicative of growth.

The question now is whether weakness in manufacturing will spill out into the services sector, a development that would leave the global economy highly vulnerable to any further negative shocks.

“As long as services continue to grow, the economy will still grow. But if manufacturing weighs down services, then the risks of it turning the business cycle intensify,” Alexander said.

Other signs of weakness in the global economy have also emerged, including a rush of investors to highly rated government bonds.

The demand has been enough in some cases to push yields on longer term notes below those of shorter term bills, resulting in an inverted yield in the U.S., Canada and U.K. markets — considered a harbinger of a potential downturn.

Indeed, things are “likely to get worse before they get better” in the fragile global economy given the deepening U.s.-china trade dispute, rising likelihood of a disorderly Brexit and the escalation of tensions between two major oil producers Saudi Arabia and Iran, Alexander said.

The U.S. is preparing to implement new tariffs on US$125 billion of Chinese imports including a wide range of consumer goods. Meantime, an escalating dispute between Saudi Arabia and Iran risks disrupting oil production and transportation. A supply shock holds the potential to spark a downturn.

Central banks have responded with stimulus. In just the last few months, the institutions have flipped the global monetary policy stance from gradual tightening to easing — a scale of reversal not seen since the great recession, Alexander noted.

With inflation growing roughly in line with its two-per-cent target, the Bank of Canada is in a position to follow, though a cut in rates here is “far from assured.”

Deloitte expects the loonie to average US75 cents through the end of next year, helping to support Canadian export competitiveness.

Deloitte expects the benefit of net trade and investment will be offset by a softening in overseas demand and moderation in U.S. economic growth that slowed to two per cent in the second quarter.

Business investment will continue to face headwinds from escalating uncertainty and diminished confidence.

If the world economy stumbles, then Canada will import the weakness from abroad.