Remarks by Carolyn A. Wilkins
Senior Deputy Governor of the Bank of Canada
Saskatchewan Trade & Export Partnership
Regina, Saskatchewan
September 6, 2018
An Update on Canada's
Economic Resilience
Introduction
It is great to visit Regina during the waning days of summer. I would like to thank
Chris Dekker of the Saskatchewan Trade & Export Partnership for the invitation
to give an update on Canada's economic performance, and discuss the Bank of
Canada's
interest-rate announcement yesterday.
The big picture over the summer has been that the global economy is doing well,
despite some troubling developments on the trade front. Many countries around
the world are continuing to grow and put people back to work. Here in Canada
the economy has shown its resilience, operating near capacity for the past
year-the first time that has happened since the global financial crisis.
Next week marks 10 years since Lehman Brothers failed; and, after many fits
and starts, this period of sustained growth seems like it has been a long time
coming. Since the crisis, people in Saskatchewan have also been forced to deal
with the consequences of the plunge in oil prices that started in 2014, and lower
prices for many other commodities. The Saskatchewan economy returned to
growth last year, and it is good to see the expansion here is continuing.
The Canadian economy is now on a solid footing, although we are feeling some
headwinds from the trade environment. The recent US tariffs on steel and
aluminum mean losses on both sides of the border. Trade disputes between the
United States and China are affecting Canadian commodity producers too. And
uncertainty about the North American Free Trade Agreement (NAFTA) means a
number of businesses are wary of making investments in capacity that would
help them take advantage of improved global demand.
I know that these issues are top of mind for many here today. For any business,
facing the challenges that come with uncertainty is crucial.
- 2 -
Farming in Saskatchewan is now an impressively high-tech business. Yet, to
succeed, business leaders in this sector still need to deal with the vagaries of
Mother Nature and global commodity prices. Decisions must still be taken and
followed through on.
Bank of Canada's Governing
It is surprisingly similar for the Council. We have
some finely honed economic models to guide us, yet we must take decisions
about the policy interest rate amid many unknowns to meet our inflation
objective. We also must follow through by communicating with Canadians and
with financial markets about our outlook for the economy and inflation.
With that in mind, my remarks today will cover three points: First, how the
Canadian economy has evolved since our quarterly Monetary Policy Report
(MPR) in July; next, how we have factored developments on the trade side into
Governing Council's
our outlook; and, finally, I will give you a sense of
deliberations that led to our decision yesterday to hold our policy rate steady.
Recent economic developments
When it comes to economic developments, Canada has been thrown several
curve balls over the past decade: the financial crisis; lower commodity prices;
and now, trade tensions. It was only a little over a year ago that we could see
that the adjustment to lower oil prices was sufficiently behind us to begin
withdrawing the monetary stimulus we had put in place in 2015. We have raised
the policy rate four times since July 2017, to 1 1/2 per cent. During this period,
overall Canadian economic performance has been solid and broad-based.
Growth has been running close to potential, the rate at which the economy can
grow on a sustained basis without sparking too much inflation. And core inflation
measures are now around 2 per cent.
Today, the policy rate is still relatively low-by that I mean that it is lower than
what we would consider to be a "neutral" rate of
interest.1 The data and other
information we have received since July reaffirm Governing Council's view that
higher interest rates will be required to achieve our inflation target.
In fact, the global economy is performing largely as we expected, and that is a
good thing because it will support growth here at home. Our neighbour to the
south has seen particularly strong demand, driven by household and business
spending. Some jurisdictions, though, are showing signs of weaker momentum,
which may be partly linked to trade measures and uncertainty about trade policy.
Meanwhile, the most recent data for Canada indicate that growth should average
near potential over the next couple of years.
Some of you might recall that in our July forecast we were counting on a quick
rebound from the marked slowdown in gross domestic product (GDP) growth that
we saw during the first quarter of this year. This was an important call because it
- 3 -
lent support to our view that July was the right time to raise interest rates by
25 basis points.
The GDP data released last week by Statistics Canada show that we were right
on the money; the economy grew at an annual pace of 2.9 per cent between
April and June, twice the pace we saw earlier this year. Growth was fuelled by
consumption and exports and, to a lesser extent, business investment and
government spending.2 The data support our view that the shift in demand
toward exports and investment is continuing. Healthy growth in consumption and
home renovations also indicates that households are generally adjusting well to
higher interest rates.3
A wide range of sectors are contributing to these developments. The resource
sector continues to expand after a few tough years. The services sector is also
growing in many high value-added areas. For example, in the second quarter
computer system design and related services grew more than 10 per cent from a
year earlier.
We expect the quarterly profile of GDP growth to be volatile for the rest of 2018,
but to still average around 2 per cent. Temporary factors that pushed up exports
in the second quarter are expected to unwind, and there have been some
outages in the oil sector. Those factors will likely weigh on growth in the third
quarter, but do not point to weaker underlying momentum.
All of this is encouraging. And we are making progress in understanding some of
the issues that have been on our minds for a while.
The first relates to the housing market and household debt, and how they are
responding to a wide range of policy changes. These include the tighter
guidelines for mortgage financing that came into effect in January, some
provincial measures to target specific housing markets and, of course, higher
interest rates over the past year.4
We saw resale activity in the housing market slow markedly at the beginning of
2018, particularly in the greater Toronto and Vancouver areas. This swing was
amplified by the fact that many households had rushed to secure their financing
and complete transactions ahead of the new rules coming into effect. Recent
data show that in Toronto resales are rebounding and prices are stabilizing too,
2
Business investment growth slowed from the first quarter, as investments in machinery and equipment
and in intellectual property products returned to more normal rates after recording double-digit growth
earlier in the year.
3
See Box 3 of the July MPR for an assessment of how increases in interest rates will affect people who will
need to renew their mortgages over the next couple of years.
4
On January 1, 2018, the Office of the Superintendent of Financial Institutions (OSFI) introduced the
revised "Guideline B-20." The guideline imposes a more stringent stress test on borrowers seeking new
uninsured mortgages by stipulating that lenders should require such households to demonstrate that they
could still service their debt at a higher interest rate. In terms of provincial measures, the "Homes for
B.C." plan included an expanded foreign buyer tax as well as additional tax and transparency measures.
- 4 -
although in Vancouver activity and price growth remain subdued. Other urban
markets that had weakened, such as Regina and Saskatoon, have steadied or
shown some recovery.
So, on a national basis, sales and prices appear to be stabilizing.
This suggests that borrowers and lenders are adjusting to the range of policy
changes as anticipated, and that financial vulnerabilities are beginning to ease.
Growth in household credit has slowed, and the household debt-to-income ratio
is edging lower. We see an improvement in the quality of new uninsured
mortgages, resulting in a smaller proportion of these households becoming highly
indebted.5 What I mean by highly indebted is households with loan-to-income
ratios above 450 per cent. These are early positive signs, and we will have an
even better view of developments as the data come in.
A second issue that we are always working to better understand relates to
developments on the inflation front. The companies that participated in our
Business Outlook Survey (BOS) during the second quarter told us that capacity
pressures and labour shortages were intensifying. Yet, wages were rising less
quickly than we would expect in an economy that is near capacity. The latest
data indicate that this is still the case: Our preferred measure of wage gains was
up by just under 2 1⁄2 per cent in the second quarter.
That said, inflation data for July surprised us on the upside by coming in at 3 per
cent. We had expected that inflation would average around 2 1⁄2 per cent in the
third and fourth quarters, rising toward the upper end of our target range because
of temporary factors such as gasoline prices, rather than pressure from excess
demand.6 Since much of the July surprise was due to a jump in the airfare
component of the consumer price index (CPI), we continue to hold this view.
Here is where our measures of core inflation are particularly valuable as
operational guides, because they strip out a lot of the noise. Those measures
have remained around 2 per cent, supporting our assessment that the inflation
increase will be temporary.
Factoring the trade policy environment into the outlook
Let me turn now to the final issue-the trade environment-which has been top
of mind for some time given its importance to economic prospects here at home
and abroad. And, while Canadian officials have been working hard to resolve the
issues, a lot of uncertainty remains.
Canadian businesses are telling us that trade tensions are among several factors
keeping them from investing in new capacity, even though both demand and
investment intentions are strong in many sectors. Here in Saskatchewan, we
have spoken with firms whose investment plans are in flux pending more clarity
- 5 -
about NAFTA. Others are exploring whether to invest across the border instead
of in Canada. These kinds of responses to uncertainty are not adequately
captured by our economic models, so we need to apply judgment. This judgment
is informed by our quarterly BOS, as well as by other discussions we have with
business people across Canada. Canada is not alone in this-we expect that
investment in many other jurisdictions is suffering from similar effects.
To assess the impact of the tariffs that have been announced, we followed two
steps. The first step was to look at the potential long-term effects of the recent
tariff changes. We used a new model developed by staff that is described in a
staff analytical note published this morning.7 It provides an excellent framework
for mapping how trade flows might change and how resources might shift across
sectors over a long period of time. The second step was to consider the
shorterterm effects-what might happen as businesses and workers adjust over the
transition period. This is a process that is too complex for models to fully capture,
yet is important to understand for monetary policy. Of course, we also accounted
for the effects of countermeasures implemented by the Canadian government.
Taken together, the Bank estimates that the combination of reduced confidence
and trade measures already taken will shave about two-thirds of 1 per cent from
GDP in Canada by 2020.8
We are seeing the effects already. June trade data showed steel exports fell the
most since 2008, with little movement in July. Moreover, the value of consumer
goods subject to a 10-per cent import tariff fell almost 23 per cent in July,
following a run-up in the previous months.
Canada's countermeasures would
Regarding inflation, we estimated that
temporarily boost inflation by about 0.1 percentage point until the third quarter of
2019. The most recent inflation report from Statistics Canada showed no impact
from the tariffs on prices to date. Still, some beer and pop manufacturers have
announced plans to raise prices in response to the rising cost of aluminum cans.
The outlook for growth and inflation in Canada is also affected by tariff disputes
between big players such as the United States and China. These disputes can
cause shifts in global markets that affect the prices of many of the commodities
we produce. Reflecting this, the prices of base metals and some agricultural
products have softened. Saskatchewan was among the provinces to experience
this effect earlier in the summer.
It is important to recognize that the challenges facing Canadian exporters are not
only about NAFTA and tariffs. Concerns about weak business investment, firms
7
See K. Charbonneau and A. Landry, "Estimating the Impacts of Tariff Changes: Two Illustrative
Scenarios," Bank of Canada Staff Analytical Note No. 2018-29 (September 2018).
8
This estimate includes the impact of tariffs previously imposed by the United States on Canadian
softwood lumber and newsprint as well as the new tariffs on steel and aluminum. Table 4 of the July MPR
provides details on these tariffs. Although the US International Trade Commission recently overturned the
newsprint tariffs, this is not expected to meaningfully change the estimate from the July MPR.
- 6 -
building new capacity outside our borders, and declining market shares existed
long before the current trade tensions emerged. Competitiveness issues have
been hampering Canadian businesses for some time, even while foreign demand
has been growing.
for Canada's
Market share in the United States non-energy goods has, in fact,
been declining over the past 15 years.9 The effect has been particularly acute in
the manufacturing sector. This trend has meant a much lower share of
employment for most manufacturing industries, including automotive and parts
and clothing. Regardless of what transpires on the trade policy front, the Bank
will still need to better understand the competitiveness issues to assess the
extent to which Canada has permanently lost market share and export
capacity.10
Yesterday's
decision
Let me now turn to Governing Council's policy deliberations that led to
yesterday's decision. It will not surprise you to hear that the implications of the
current trade environment were front and centre. As I just outlined, we have
already incorporated into our forecast the expected negative effects of
uncertainty on business investment and exports, as well as the effects of US
tariffs and Canadian countermeasures imposed so far. These estimates are
highly uncertain and may need to be adjusted as we get more information about
the NAFTA negotiations and how businesses are adjusting their plans.
Our practice is to not incorporate scenarios that have yet to occur, even though
they may be the subject of ongoing discussions. That said, the risks to growth
related to trade policies are not just on the downside, particularly in light of the
ongoing negotiations. There is some significant upside as well.
Nonetheless, it is important to understand that certain trade developments can
result in complex trade-offs for monetary policy.
On the one hand, protectionist measures can be costly in terms of growth and
incomes, particularly as businesses and people adjust. A recent study by the
Bank for International Settlements (BIS) shows how virtually all regions in
Canada, Mexico and the United States could expect lower real wages if these
countries reverted from NAFTA to World Trade Organization tariff rates.11
On the other hand, protectionist measures create risks to the upside for inflation,
especially when the economy is operating near full capacity. In weighing these
- 7 -
trade-offs, you can be sure that Governing Council will not lose sight of our
primary mission. Low and stable inflation will help reduce at least one source of
uncertainty for companies and households. Of course, there are a number of
structural and other policies that are better suited than monetary policy to help
manage what would be complex adjustments.
Governing Council also discussed whether the gradual approach to raising rates
that we have been taking over the past year remains appropriate. It is a natural
question to ask, given that the economy has been operating at potential for the
past year and it is in this part of the cycle when interest rates typically rise to
preempt a buildup in inflation pressures. As I mentioned earlier, the factors that are
pushing inflation to the top of our target band appear to be temporary and not
signs of excess demand. These factors mean that inflation could turn out to be
higher over the next couple of quarters than we had expected in July, but will
most likely fall off afterward barring any new price shocks.
We will need to do a full update of our inflation outlook for the October MPR, but
we already have a good idea of when the effects of the temporary factors at play
right now are likely to dissipate. For example, the increases in gasoline prices
from earlier this year are contributing 0.7 percentage point to above-target
inflation today. This effect will largely recede by the first quarter of next year. We
have seen this in the past, since fluctuations in energy prices have accounted for
about three-quarters of the overall movement in inflation. To do our job without
causing undue volatility in growth, we look through these factors, while remaining
alert to signs of underlying inflation pressures.
Furthermore, we still acknowledge that there may be more room to grow without
causing inflation than we have built into our forecast. We also know that high
levels of household debt have made the economy more sensitive to interest-rate
increases than in the past. That is because people must commit more of their
income to servicing their debt when borrowing cost rise, leaving less for other
spending. The fact that the job market has been particularly strong, and that
average household incomes are rising, helps this adjustment. Consumer
confidence has also been relatively high. All this suggests that the economy is
adjusting well and can adapt to higher interest rates.
The bottom line is that Governing Council agreed that the gradual approach we
have been following is still appropriate.
Finally, we discussed how much momentum remains in the global expansion.
Few would disagree that the United States is showing considerable strength, but
some commentators see a relatively flat US yield curve as a sign of trouble
ahead. While there are downside risks to any outlook, Governing Council prefers
to look at a broader range of indicators. For one thing, the yield curve is not
currently inverted, and is therefore not pointing to significant slowing.12 Besides
that, the shape of the curve may not be a reliable signal in the current
environment anyway. This is because longer-dated bond yields are being
12
See E. Engstrom and S. Sharpe. "(Don't Fear) The Yield Curve," FEDS Notes. Washington: Board of
Governors of the Federal Reserve System (June 28, 2018).
- 8 -
distorted by a combination of central bank quantitative easing programs and
strong private demand for long-dated safe assets. Other indicators to look at
include credit spreads, which remain narrow.13 There may be some downside
risk to our July outlook for the global economy coming from trade tensions, and
cracks have appeared in certain emerging economies with financial
vulnerabilities, but with limited spillovers to other countries.
Conclusion
It is time for me to conclude. In terms of momentum in Canada, we are
encouraged that the economy is adjusting well to higher borrowing rates and
tighter guidelines for mortgage financing. We are also pleased with the continued
shift in the composition of growth toward exports and business investment.
Recent data reinforce Governing Council's assessment that higher interest rates
will be warranted to achieve the inflation target. We will continue to take a
gradual approach, guided by incoming data. In particular, the Bank continues to
gauge the economy's reaction to higher interest rates. The Bank is also
monitoring closely the course of NAFTA negotiations and other trade policy
developments, and their impact on the inflation outlook.