Canada’s GDP Growth Hampered by U.S.-European Reverse Images on Austerity

03/01/2013 by Alex Carrick


The nation’s latest gross domestic product (GDP) results have just been released by Statistics Canada. Q4 2012’s “real” or constant-dollar (i.e., adjusted for inflation) rate of change versus Q3 was +0.2%, the same as for Q3 versus Q2.

The annualized rate of change in the latest quarter was +0.6%. For full-year 2012, Canada’s real annual GDP growth was +1.8%, a decline from 2011’s +2.6%.

In the individual month of December, industry-based GDP declined 0.2%, taking away most of November’s 0.3% gain. In the preceding three months, August through October, the month-to-month change averaged 0.0%.

The monthly GDP curve is flattening out. Our former strengths are abandoning us. Housing construction is slowing, especially in the formerly hot high-rise (i.e., condo) market. A weaker residential real estate market will be felt in both retail sales and manufacturing activity.

Through lower mortgage lending activity, it will also cut into revenue in the nation’s important banking sector.

In resources, commodity prices have retreated from their previous peak and appear content to slumber for a while longer.

There is one exception. Lumber prices have been soaring. A sharp upward trend in U.S. new home starts has been the reason. In the latest Industrial Product Price Index (IPPI) report, the lumber sub-index was +9.0% year over year. 

Our governments at both the federal and provincial levels are embracing austerity, which will limit their ability to promote growth over the period ahead.

There’s even discouraging news in non-residential construction, which has been a reliable source of new investment over many years, thanks to mega energy projects and/or public stimulus efforts. In 2013, it’s about to take a break.

The latest Private and Public Investment (PPI) survey suggests a year-over-year change in construction and machinery and equipment investment that will be minimally ahead on a current-dollar (i.e., not adjusted for inflation) basis and probably slightly negative in constant dollars.

Therefore, Canada – and indeed the world at large – must now count on the U.S. to record a respectable level of growth to pull the rest of us in its wake. Full-year U.S. GDP real growth in 2012 versus 2011 was +2.2%, an increase from the previous year’s advance of +1.8%.

Most of the U.S. strength at present is tied to the housing sector, which has been coming through in stellar fashion. New home starts south of the border are trending sharply upwards.

Resale home prices according to the three major measures – provided by S&P/Case-Shiller, the Federal Housing Finance Authority (FHFA) and the National Association of Realtors (NAR) – are in a range of +5% to +12% year over year.

The biggest hazard for the U.S. economy is the political free-for-all in Washington. It’s uncertain just how negatively “sequestration”, if it happens as scheduled on March 1, will affect overall activity levels. Plus there’s the debt-ceiling issue still to be resolved at the end of this month.

The U.S. monetary policy framework is a little more settled and easier to follow, although it is also the subject of some controversy at present.

The Fed’s current policy of buying $85 billion in bonds each month, split about evenly between Treasury Bills and mortgage-backed bonds provided by Fannie Mae and Freddie Mac, is keeping interest rates low and providing help for the housing industry.

Some regional Governors of the Fed are beginning to wonder if the special stimulus shouldn’t be withdrawn sooner rather than later. They argue that housing is clearly on the mend and that too much extra money is bound to create inequities eventually.

In other words, that’s how speculative bubbles are born.

As long as GDP growth remains below potential and labor continues to be vastly underutilized – as reflected in the 7.9% unemployment rate – the Chairman of the Fed, Ben Bernanke, will be unlikely to alter his stance from “dove” to “hawk”.

The stated policy of the fed is that the official interest rate (i.e., the “fed funds rate”) will stay near zero until the jobless figure is in striking distance of 6.5%, with the caveat that inflation must be 2.5% or less.

Similar arguments are being hashed out in Europe. The European Central Bank’s (ECB) policy-setting interest rate sits at 0.75% and Mario Draghi has stated he sees no reason to move it higher.

In 2013, the 17-nation Euro zone is expected to record a second year of modestly negative GDP change. The general price level isn’t expected to climb higher than +2.0% year over year all the way through 2014.

The United Kingdom appears to be entering a triple-dip recession. Mark Carney – presently Governor of the Bank of Canada but soon to be head of the Bank of England – will face a difficult challenge as soon as he takes office in June. His predecessor, Mervyn King, has been blocked in attempts to undertake a more-aggressive U.S.-style bond buying program.

Continuing weak economic growth isn’t the only reason the ECB will be keeping its foot on the monetary accelerator. Similar to the U.S., politics is playing a role, but it’s almost a reverse image.

Electorates on the continent are increasingly expressing their dissatisfaction with government cost-cutting measures. In Italy, the Democratic Party led by Pier Luigi Bersani recently won a majority in the lower house of parliament, but failed to dominate the equally-important Senate.

To rule properly, Mr. Bersani will need coalition support from either the anti-austerity forces of Beppe Grillo, a former professional comedian, or Silvio Berlusconi, a three-time former Prime Minister who has supplied many comedic moments of his own, but of a more semi-tragic nature.

The fear is that political gridlock will cause Italy to relax its “good fight” to rein in the public sector. This might lead to a domino effect in Spain, where youth unemployment is nearly 50%, and in Portugal and Greece.

As a result of Italy’s election, the yield on the country’s 10-year bonds has risen to nearly 4.75%. The threshold at which European nations have found themselves with spiraling-out-of-control and must-be-addressed financing problems has been 7.00%.

By way of comparison, U.S. 10-year Treasury Notes are now earning 1.90%, although that’s up from a record-low 1.38% last July.

The interest rate on decade-long German bunds at 1.45% is lower than for U.S. Treasuries.

Spain is now paying 5.14% for its long-term notes and Portugal, 6.33%. Greece, the granddaddy of all credit-troubled nations, is on the hook for over 11.00%.

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