July 8th - 2009

Canadian dollar to again outpace American, economist say

The economy is beginning to respond to stimulus by the Bank of Canada, but Canadians can expect to see a very different economy when the smoke clears.

The economy is beginning to respond to stimulus by the Bank of Canada, but Canadians can expect to see a very different economy when the smoke clears. That was one of the messages Senior Economist for CIBC World Markets, Benjamin Tal had for delegates at the recent Land and Development Conference held in Toronto.

The CIBC economists predict the economic landscape over the next decade will see a return to inflation in the U.S., a Canadian dollar above par, a solid run for stocks and resource prices, and the emergence of Asian consumer spending. The report dubs the next decade the “teenage years,” and like teenagers, it expects financial markets and the economy could be moody and unpredictable early on, but ultimately, grow and mature.

Tal says Canada’s real estate market has not experienced the free fall experienced in the U.S. because we don’t have the same subprime component. However, what happens in the U.S. has an impact on the Canadian economy he says.

His presentation examined the key trends in the North American economy with a specific view towards their future direction over the short and long term, including the outlook for GDP growth, interest rates, energy and commodity prices, the value of the Canadian dollar, and the rate of inflation. Tal gave his predictions for when the U.S. and Canadian economies will start to recover and how much deeper the recession is likely to be in Canada.

His presentation mirrored information found in CIBC World Markets Inc.’s latest economic report co-produced by Tal and CIBC Chief Economist Avery Shenfield. The report released at the end of May states the next decade will see a return to growth, but the economic landscape will be very different from the previous 10 years. “Although the banking crisis is over, the recession is not,” says Tal.

Here are some of the other findings in Tal and Shenfield’s report:

While U.S. consumers will be cutting back on spending and saving more to pay down debt, CIBC does not expect tax hikes to be the full solution to the growing weight of government debt. They believe inflation may be part of the answer to both the public and private debt excesses of our southern neighbours. "Letting inflation run at five per cent for a few years in the early part of the decade would go a long way to digging the U.S. out of its debt mountain. The debt/GDP ratio has nominal GDP in the denominator-so raising inflation lowers the debt burden. And higher inflation would help stabilize or even boost nominal house prices, key to allowing a return to positive home equity for those with mortgages that now threaten to exceed the house price.

Since Canada will not face nearly America's debt burden, nor its underwater mortgages, letting inflation run above the central bank's two per cent target will be much less tempting. A strong Canadian dollar will also dampen import price inflation. Expect an inflation gap to see Treasury yields well above those on Canadian bonds in the first half of the next decade as a result.

U.S. dollar devaluation and higher U.S. inflation will help boost commodity prices and Canada's corporate bottom line, particularly given that economic development in the Far East tends to be more resource intensive than the more services-oriented economies of North America. For the U.S., a weaker dollar will be key to promoting both net exports and capital spending at home, by making "Made in America" less of a cost disadvantage.

For the Canadian economy, these shifts will mean a leaner decade for segments of the economy leveraged to American consumer spending (like automotive equipment, newsprint, lumber for U.S. housing). Reduced Canadian leveraging will also see housing starts average a tame 170,000 in the decade of the teens, after having averaged near 200,000 for the current decade to date. Instead, faster growth will be driven in sectors (technology, materials) linked to either North American capital spending or Asian consumption. Financial services will earn their keep by helping Canadians manage a newly growing pool of savings.

While the Canadian dollar will climb as the U.S. dollar weakens and hurt our manufacturing competitiveness, rising resource prices will reignite capital-intensive development of the oil sands, natural gas projects, and metal mines. That will allow private investment spending to increase its share of the economy as governments pull back on public infrastructure. The firmer Canadian dollar will also give Canadian households added import spending power.”

The complete CIBC World Markets report is available here.

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