OECD Economic Outlook, Volume 2018 Issue 1

Canada

Slower growth since the second half of 2017 is projected to give way to growth of over 2% from mid‑2018. The uplift will be export‑led, reflecting gradual restoration of oil pipeline capacity and strong US growth. Business investment is projected to strengthen to ease tightening capacity constraints. Unemployment should decline further to record lows.

The Bank of Canada is projected to gradually withdraw monetary stimulus, and the inflation rate is set to remain slightly above 2%. Further rate increases will be required to meet the Bank’s (medium‑term) inflation target. Fiscal policy is also projected to tighten somewhat, creating room to support the economy during the next downturn and reducing the extent to which interest rates need to rise. Macro‑prudential policy has been gradually tightened, and there are signs that housing markets are stabilising. Nevertheless, further adjustments may prove necessary should the balance of risks change. Government funding for childcare should be increased further in a fiscally neutral way to raise female employment, reduce the gender earnings gap and make growth more inclusive.

Economic growth has eased to more sustainable rates

Economic growth has slowed to more sustainable rates since mid‑2017, driven by slower increases in private consumption and exports. The removal of some monetary stimulus and smaller wealth gains from house price appreciation have curbed consumption. Export weakness on the other hand reflects an anticipated adjustment in automobile production and the outage of an oil and gas pipeline, from which full recovery is expected to occur only by mid‑2018. Business investment has picked up, supported by high levels of capacity utilisation outside the oil and gas sector, but upstream oil and gas investment is being held back by pipeline capacity constraints and regulatory barriers to expansion. Forward‑looking indicators suggest that business investment will remain firm.

Canada

Source: OECD Economic Outlook 103 database; and Teranet and National Bank of Canada, House Price Index.

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Employment growth has been strong, reducing the unemployment rate to a 40‑year low and below the OECD’s (albeit uncertain) estimate of the structural rate. Hourly wage growth has picked up for full and part‑time employees. Wages will be boosted over the next few years by changes in provincial minimum wages. Consumer price inflation has risen to slightly above the mid‑point of the Bank’s 1‑3% annual medium‑term target band. The average of the Bank’s preferred underlying inflation measures has reached 2.0%. Inflation expectations have picked up but remain well anchored, with almost all firms expecting inflation to fall within the target band.

Canada. Demand, output and prices

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Macroeconomic policies are becoming less accommodative

Some monetary policy stimulus has already been withdrawn through three official interest rate increases since mid‑2017. With core inflation already at the mid‑point of the target band and excess capacity projected to be used up by late 2018, the Bank of Canada is projected to increase its official rate by a further 75 basis points, to 2%, by late 2019. This is below its estimate of the neutral rate (2.5‑3.5%). Further rate increases will be required to keep the inflation rate close to the mid‑point of the inflation target band over the medium term. Rising global long‑term interest rates will push up their Canadian counterparts, further tightening monetary conditions. Sensitivity to interest rate increases is likely to be greater than usual owing to the high level of household debt. Recently, mortgage underwriting requirements for uninsured loans were also tightened considerably. This measure and tax increases on non‑resident owners in British Columbia have reduced house price appreciation and, together with higher mortgage rates, should continue to deliver subdued price increases. Even so, house prices and household debt will remain high, especially in Toronto and Vancouver where important affordability challenges remain.

Canada

1. Deviation of aggregate hours worked from their estimated potential level.

2. Composite measure of wage pressures summarising data from the Labour Force Survey, National Accounts, Productivity Accounts, and Survey of Employment, Payrolls and Hours. For more detail, see Brouillette et al. (2018).

3. Average of the Bank of Canada's three preferred core inflation measures (CPI‑trim, median and common).

Source: OECD Economic Outlook 103 database; D. Brouillette et al. (2018), Wages: Measurement and Key Drivers, Staff Analytical Note 2018-2, Bank of Canada; Bank of Canada (2018), Monetary Policy Report, April; and Statistics Canada, Tables 326‑0022 and 326‑0023.

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The overall pace of fiscal easing has slowed, which is appropriate for this stage of the business cycle. The underlying primary balance is estimated to have fallen by 1.8 percentage points of GDP between 2015 and 2017 but may drop only 0.5 points over the next two years. The slightly expansionary stance over 2018‑19 reflects budget developments in Ontario. The federal government’s stance is slightly contractionary, despite the delay of around one half of Budget 2016's infrastructure stimulus. That stimulus supported the economy during the weak patch caused by the fall in oil prices but, with adjustment now complete and the economy back around potential, such support is no longer needed.

Uncertainty about the future of NAFTA and other aspects of US trade policy are weighing on the outlook and damping business investment. The Bank of Canada estimates that trade policy uncertainty could reduce the level of business investment and exports by 2% and 0.7%, respectively, by the end of 2019. The Bank also estimates that the US corporate tax cut will reduce investment in Canada by 0.5% by the end of 2019.

Growth is projected to strengthen

Following slower economic growth since mid‑2017, growth is projected to rise to somewhat over 2% from mid‑2018, led by exports and business investment. Restoration of oil and gas pipeline capacity and strong US demand growth will boost exports. Business investment will be supported by capacity constraints, high profitability and still low financing costs. The unemployment rate is projected to fall to 5.5% in 2019, a record low, and wage pressures to intensify. As a result, inflation is projected to remain slightly above the midpoint of the target range in 2019. A major downside risk is that access to the US market becomes less favourable, including through termination of NAFTA. Another is that inflation rises more than projected, necessitating sharper interest rate increases that together with the associated weakening in growth would impair many households’ ability to service their mortgages, leading to a housing market correction. On the other hand, growth would be higher if uncertainty over access to the US market were to be resolved on no less favourable terms or regulatory barriers to increasing pipeline capacity were to be resolved.