Small Business

Podcast 11 Transcript: Economic outlook: Dollar parity, rates

Written by Ian Portsmouth

Ian: : Welcome to the Business Coach Podcast, an advice-oriented series for Canadian entrepreneurs. I’m Ian Portsmouth, Editor of PROFIT Magazine and I’ll be your host as we tackle the hot issues and opportunities facing Canada’s small businesses. We’ve developed this podcast in cooperation with BMO Bank of Montreal. Over the course of the series I’ll be drawing on experts in a number of fields including some BMO experts in order to provide the credible information and prescription you need to run your small business better.

Well it’s certainly been an interesting few weeks. The Loonie has achieved parity with the greenback, the US sub prime mortgage market has triggered a credit crunch and the US Federal Reserve has cut interest rates to spur the US economy. Joining me to apply some method to all of this apparent madness is Doug Porter, Deputy Chief Economist of BMO Capital Markets. Doug welcome to the Business Coach.

Doug: Oh thank you.

Ian: : Now Doug it really has been kind of crazy to the casual observer across the economy over the past month or so. How complicated is the current economic scenario, as compared with recent years according to your experience?

Doug: Well you know there are always different forces that are at play on the economy that cause a little bit of complication but I would say that now is a little bit more complicated than usual. We’ve got two extraordinarily conflicting forces at play in Canada right now. On the weak side of course the manufacturing sector is dealing with a very strong Canadian dollar and the economy more generally is dealing with the very real fallout we’re seeing in the contraction in US housing, and just to add to the mix we have had this squeeze in the credit markets in recent months. But on the flip side, on the very strong side of course the commodity price boom just keeps going and pushing Western Canada to new heights. We’ve got a very, very strong domestic housing market and finally our labour market is exceptionally strong. We’ve got the lowest unemployment rate in 33 years. So basically policy makers are dealing with this very unusual situation where we have some very strong forces and some very weak forces. So in a nutshell it is a complicated backdrop, probably more so than usual.

Ian: : So there’s a whole pile of stuff there and at the top of the pile I think in most people’s minds is the dollar. Where is the Loonie going and how fast is it going?

Doug: Well of course economists have not exactly covered themselves in glory in calling the currency in recent years. I think very few were expecting it to rise anywhere close to this extent. But you know quite frankly I think that the two biggest, biggest forces in play driving the currency, strong commodity prices and a weak US dollar, neither one is going away soon and you know I simply would not want to you know forecast the end of this incredible run we’ve seen. The currency is now at more than 60% from it’s lows and I, I think it will test it’s modern-day high of just over a little of 105 cents US. Now in the second half of next year we do believe that the currency will begin to recede a bit. In recent days it probably has overshot it’s fundamentals a bit and I think ultimately it will recede back below parity, but in the meantime I wouldn’t be surprised if it goes even higher yet.

Ian: : Now many predicted that the Loonie would never get to a dollar, but they also predicted that the export economy would collapse once the Loonie reached 80 cents US, so what’s absorbed the blow and how concerned should exporters really be with the Loonie at parity.

Doug: I think exporters are probably still very concerned, but one thing I would say is that probably a lot of the weakest manufacturers have already been weeded out and, and the firms that are left are still extremely competitive. But another thing that’s really helped cushion the blow for the economy is the fact that there is an absolute global boom going on outside of North America. There is just an incredible split between the strengths in exports to the rest of the world where we’ve actually seen sales rise by about 25% in the past year versus the struggling US economy where we’ve seen Canadian exports drop by 3%. So that, that so-called de-coupling between the rest of the world and the US economy has been one thing helping keep Canadian exporters on track and the other thing has again been the, just the general strength in commodity prices which of course has helped all commodity producers and exporters.

Ian: : So let’s talk about the Loonie versus some other currencies. The Loonie is certainly outperforming the US dollar but it doesn’t seem to be changing a lot versus many other currencies. What’s the situation there and how does that bode for Canadian trade in foreign markets?

Doug: Well when you look at it over a longer period of time, say the last 5 years, the Canadian dollar actually doesn’t really stand out that much. It’s, it’s more or less moved in line with the Australian dollar or the Euro. It’s been a little bit stronger than say the Swiss Franc or the UK Pound, but generally it really hasn’t been you know a star performer outdistancing everyone else. Now that has changed a little bit in 2007, among the major currencies and the Canadian dollar really does stand head and shoulders above all other major currencies, so the Canadian dollar has strengthened a bit against basically every major currency in the world this year so that suggests that some of that export strength we’re seeing outside of North America could fade a bit in the next couple of years. But what, you know where I think we will see some other currencies begin to rise versus the Canadian dollar is I do think we’re going to start seeing some of the Asian currencies now kick into a higher gear and start, start to finally rise against the European currencies and the Canadian dollar.

Ian: : Now despite all of this the US is still Canada’s largest trading partner by a wide margin. What’s your forecast for US growth and do you see a recession anywhere on the horizon?

Doug: Well over the past year we’ve seen the US economy essentially muddle through with growth of a little bit less than 2% and we see something on that order over the next 4 quarters as well. If anything we think it might even be a little bit weaker yet, just because of the, the tighter credit conditions that we’re likely to face. Housing of course has been the biggest drag on the US economy. It will continue to be a big drag on the US economy and I would say that the real risk at this point is that weakness in housing spilling over into the consumer spending side. It hasn’t happened yet, but I would say that the US economy and the consumer in particular would be vulnerable to any sort of unexpected shock at this point for instance, you know another run up in oil prices. I would put the risks of a recession in the US at about a 1 in 3 chance over the next year which is significant, but still less than 50/50. I think the more likely scenario is that we’ll sort of have a muddling through of the US economy of about one and a half to two percent growth.

Ian: : Now we’ve seen some recent changes at the US Federal Reserve. Where are interest rates going stateside and what about Canada?

Doug: Yeah the Federal Reserve of course cut rates aggressively in September by a half a percentage point. I, I don’t think the Fed is done cutting rates. Their key lending rate is probably still a little bit higher than what would be considered neutral or a natural rate of interest and given the weakness in, in housing I think there’s still room for US rates to come down. We think on balance US interest rates will drop by another three quarters of a percentage point over the next six months. In Canada, the Bank of Canada is maintaining a very neutral stance. I talked about the deeply conflicting forces at the outset and I think that those will still continue to balance themselves out, at least until the end of Governor Dodge’s term at the end of January. Then our, our view is that the next move in interest rates is more likely to be down than up. We think there is scope for a very modest cut in Canadian interest rates early next year, largely to offset the incredibly depressing impact or dampening impact of the very strong Canadian dollar on retail prices. But I think the main point is we don’t see a big move in Canadian interest rates one way or another, just because of these deeply conflicting forces at play in the economy.

Ian: : So we all know that the west is booming in Canada. Ontario and Quebec, especially their manufacturing centres have been struggling. What provinces are going to lead the pack in terms of economic growth over the next year? Which ones are going to lag and how do things average out across Canada as a whole?

Doug: Well this is no brave forecast at all, but we do see the four western provinces at the top of the leader board again in 2008. It was exactly that situation in 2007. However we do see Alberta sort of pulling a little bit back to the pack ah because the natural gas sector is struggling a lot, we see Alberta only slightly above the other western provinces but we all, we see them all in the range of 3 to 4% growth next year. In contrast at the other end of the spectrum we continue to believe Ontario will be the slowest growing province in the country. We think Ontario will be fortunate to post 2% growth. The major negatives for Ontario are the fact that the province is dealing with a very strong Canadian dollar, manufacturing sector is taking it on the chin, and Ontario is a major energy importer. So $80 oil is a clear negative for the Ontario economy. Quebec we see slightly better than Ontario but not much. On, on average what that works out to is about two and a quarter percent growth in Canada. That’s a little bit below the long-run trend, sort of an average year for the Canadian economy would be growth of about two and three quarters percent.

Ian: : And how does that put us against international markets?

Doug: It’s actually not that dissimilar. We, we see the US actually growing a little bit slower than Canada next year, in Europe we also see it in the range of about 2% and Japan is lucky any, any year nowadays to grow by 2%. So even though that’s a below average pace for Canada next year in 2008, we still think that’ll put Canada close to the top end of the G7 growth ranks for next year.

Ian: : Now any business owner, of course they love a great economic forecast, they probably don’t like a bad economic forecast, but what they certainly appreciate is one that’s certain and a steady market. So how volatile are things right now, and what does this tell companies about the wisdom of making investments in their businesses?

Doug: Well you know even though I talked about the, you know the great complications out there in the economy right, I think one of the bigger stories in the last 10 to 20 years is a reduction in economic volatility overall. The business cycle has actually become a little bit more tame. You know when you look back to 2000 and 2001, even during the you know incredible wreckage in the tech sector, the economy overall continued to grow through that, ah that time period, and the Canadian economy has not been in a full-blown recession since early 1990. This is one of the longest stretches on record for the Canadian economy to go without going into a full-blown recession. A couple of reasons why the economy is much less volatile is because inflation remains very low and generally stable, and the government sector is now in a budget surplus position so they can, to some extent help smooth out some of the, you know some of the peaks and valleys of the business cycle. So overall there’s actually a little less economic volatility now than there would have been even 10 years ago let alone 20 years ago.

Ian: : Well Doug thanks very much. I think we will all rest a little easier tonight.

Doug: Okay thank you.

Ian: : Doug Porter is Deputy Chief Economist of BMO Capital Markets in Toronto.

Thanks for listening to this episode of The Business Coach Podcast. I hope you discovered a few insights that will help you grow your business. You can download this podcast series at, and from iTunes. Until next time I’m Ian Portsmouth, Editor of PROFIT Magazine wishing you continued success.

Originally appeared on