Small Business

Podcast 69 Transcript: Economic Update

Written by Ian Portsmouth

Ian Portsmouth: Welcome to the Business Coach Podcast, an advice-oriented series that tackles the top issues and opportunities facing Canada’s small businesses.  I’m your host, Ian Portsmouth, the Editor of PROFIT Magazine. We’ve developed this podcast in cooperation with BMO Bank of Montreal. 

Well, the federal budget dropped a couple of weeks ago and as expected, it was a stay-the-course document bearing few surprises.  But it did offer a few new goodies for business and like any federal budget, it will affect our economic fortunes to some degree in the coming years.  Joining me to discuss the budget and share what’s in the economic crystal ball is Doug Porter, Deputy Chief Economist at BMO Capital Markets.  He is on the line from his office in Toronto.  Doug, welcome to the Business Coach Podcast.

Doug Porter: Thank you for having me.

Ian Portsmouth: So, very quick synopsis, budget 2010, good, bad or ugly on the whole?

Doug Porter: I would say overall slightly good.  It was a bit of an unusual budget in that the Government was really trying to accomplish two things at once.  First, it was trying to finish off the stimulus package that was first introduced a little bit more than a year ago and that really will run the course right up until March 2011.  But at the same time, they were also trying to lay out a very specific framework for how they are going to reduce the budget deficit which will be about $50 billion both this year and next, quite sharply over the medium term to the point where we will be almost balanced 5 years out.  And they did detail some fairly specific spending restraint measures over the next few years.  But I would say, at least over the short term, the budget will continue to add a little bit of growth and government policy overall will still be on the simulative side through the course of 2010.

Ian Portsmouth: Still we have a huge deficit.  So, is it something that we need to be concerned about over the mid to long term?

Doug Porter: Well, I think we need to be vigilant and somewhat concerned about it but I think it is important to point out that Canada stands in very stead compared against almost all other major industrialized economies.  Our budget offset is smaller than any of the other G7 economies, as a share of the economy.  And certainly, our total debt load is well below that of almost every other major industrialized economy.  Really, the only country that comes close to us on either measure is Germany but, you know, say, compared to Britain or the U.S. where budgetary situation is much much more manageable.  And that goes even when you include some of the provinces that have fairly large budget deficits on their own, Canada’s situation is still quite manageable.

Ian Portsmouth: So, let’s talk about the specifics of the budget.  One significant change is the removal of tariffs on some imported manufacturing and puts.  What exactly is covered and how is this going to help manufacturers?

Doug Porter: Some people refer to this has being the real gem and the surprise in the budget and I would say that it involves the new measures and probably was, you know in terms of dollars cost, probably was the most significant.  Effectively, any kind of machine and equipment expenses that a manufacturer undertakes, and almost any input that they use in production of goods will now be care free.  It isn’t a huge dollar cost, the government estimated that it does cost them about $200 to $300 millions a year.  You know, it’s significant. But I would see really what the Government was trying to do, was trying to find low cost ways to help over the sector that probably has to this day, is still coming under the most strain, given the economic backdrop we’re facing.  And you know, I think it was a imaginative and it was helpful.  So I think it probably was the most positive aspect in the new budget.

Ian Portsmouth: Now, this isn’t news but the Government has extended its promise to reduce the corporate tax rate to 15% in 2012.  Did that come as any surprise?

Doug Porter: Well, to some people it did.  I mean, personally, I didn’t find that surprising.  I think that that was a key plank of the Government’ strategy.  But there had been a lot of talk that the corporate income tax cuts, and there will be more in a couple of years, could be sacrificed on the alter of budget restraint.  But I think improving the corporate competitiveness and doing it by cutting corporate income taxes is one of the key strategies that this Government has and in fact the prior Government had it as well.  To me, it would almost be a last ditch effort for the Government to go back on those plain corporate tax cuts.  As I said to someone, it was a bit of a mild pleasant surprise.  I think they are likely to carry through with the further cuts they have planned on that front.

Ian Portsmouth: That said, the tax rate cut could be replaced by an increase in employment insurance premiums. So what is going on there and how much will this affect employer bottom lines if the rates do go up?

Doug Porter: You know for years, there was quite a complaint that Ottawa is running these huge surpluses on the employment insurance side because the revenues were flowing in and year after year, they were cutting the employment insurance premiums quite aggressively.  Over the last couple of years, as unemployment has backed up quite rapidly, they’ve decided to freeze those premiums even though they are now running large deficits on the employment insurance front.  I suspect that what we are going to see is a relatively large increase in the employment insurance premiums next year, in 2011.  Now they do have caps on how much those employment insurance premiums can rise in a single year, 15 cents.  But I suspect we are going to hit the maximum, how we are going to hit that cap probably for the next few years as they try to address this deficit in the employment insurance account.  And realistically, a) this is a tax increase and b) this is one way that they can address the broader budget deficit, you know, almost without making a policy decision.

Ian Portsmouth: So Doug, where do you see interest rates moving?   

Doug Porter: Well the Bank of Canada made a commitment a year ago when they cut interest rates to 0.25% on their overnight rate that they were going to keep them there until the middle part of 2010.  It does look like they are going to stick to that commitment unless we get a big shock in inflation over the next little while.  But our view is that, given that the housing market has almost completely rebounded to where it was in free recession levels, given that consumer spending is coming back and given that inflation is basically back to the Bank of Canada’s 2% target, I think the Bank is actually quite uncomfortable with how low interest rates are and that they will start raising interest rates at the first decision date after their so-called conditional commitment is up.  In other words, interest rates will begin to go up in July.  They have 4 more decisions in the second half of the year.  We think at the least, they will raise interest rates by a quarter in each of these four moves.  So we think that by the end of the year, their overnight target will be 1.4%, and we think it will continue to rise over the course of 2011 as the recovery becomes more well entrenched.  We think the Bank of Canada’s overnight interest rate will be all the way up to 3.25% by the end of 2011.  Now, you know, on a historical basis, that’s still a relatively low interest rate, as the Bank of Canada, I believe, would call a normal rate or a neutral level of rates for their overnight interest rate to be a little bit  above 4%.  So, you know, in the longer scheme of things, our rate of 3 or 3.5% or somewhere in between would still be relatively low.  But certainly, it is a long way from today’s quarter per cent rate for that overnight target rate.

Ian Portsmouth: Now, anything thing tied to the stimulus is inflation and there has been a little bit of talk the last little while about Government’s lifting their inflation expectations and for instance, instead of trying to keep inflation at around 2%, they might be happy with something at 3 or 4%.  Where do you see inflation going over the mid to long term?

Doug Porter: There is a couple of points to be made there.  First of all, that talk about possibility lifting the inflation target, that is not coming from the Bank of Canada, that’s a former Chief Economist of the IMF has been talking about, how 4% inflation might make things easy to deal with.  The Bank of Canada, I think, is not in that frame of mind at all.  In fact, of anything, you know, the debate there has been whether to actually lower the inflation target from its current 2% rate.  I actually don’t think there is a lot of appetite for that either.  I think the Bank will continue to target 2% inflation over the medium term.  And by the way, they do have to come up with a new inflation target before the end of 2011 and those targets tend to last 5 years.  We are at the risk line over the near term.  I actually think the risk is a little bit to the high side of that 2% inflation target, despite the fact we have just been through a very serious recession, I think one of the big surprises is that, you know, even with that serious recession we’ve just been through, the headline inflation rate right now is almost exactly 2% and that’s also despite the fact that we’ve had the helping hand of a very strong Canadian dollar which acted to help dampened price increases.  And you know, despite all that, we still are stuck with an inflation rate pretty close to 2%.  You know, if anything, we could get inflation drifting a little bit above that over the next couple of years especially when you take into account the fact that Ontario and British Columbia will both be introducing the harmonized sales tax in the middle part of 2010.  And what that means is the provincial sales tax will now apply to a lot of goods and services especially that it didn’t apply to before when they blend their provincial sales tax with the GST.  And over the short period of time, that will actually give a little bit of a bump to headline inflation.  We could see headline inflation drift up above 2.5% even possibility close to 3% for a while in the second half of this year before it comes back down later in 2011.  But overall, I think if anything the surprise has been over the last few months or so, how sticky or high inflation has remained and the rift as the economy recovers more fully, that inflation could bump up a little bit higher than 2%

Ian Portsmouth: Now the dollar continues to fluctuate quite significantly.  Where do you see it going over the next year?

Doug Porter: Well I think, you’re right, we’re seeing just tremendous moves in the exchange rate over the last couple of years.  For instance, there was one month alone back in late 2008 where the currency dropped by 20 cents in the space of 4 short weeks.  But of course, it has recouped all of that and now we’re back close to parity, as we speak.  We tend to believe that the odds are more that the currency is likely to strengthen further from current levels over the next couple of years rather than weaken.  We do think the currency will push above parity through the second half of this year and generally stay above that through 2011.  The main reasons why we believe the currency will tend to strengthen is that as commodity prices continue to recover, that will tend to benefit the Canadian dollar.  We simply believe that there are more fundamental positives for the Canadian economy versus most other economies that will support the Canadian dollar.  And finally we do believe that the Bank of Canada will be a little bit more aggressive and early in raising interest rates than other major central banks.  And that too will tend to support the Canadian dollar.  So for all these factors, we do think that overall, the Canadian dollar is more likely to strengthen rather than weaken over the next year and half.

Ian Portsmouth: The federal government is counting on pretty good economic growth to help eliminate the deficit.  So where do you see GDP growth going over the next little while?

Doug Porter: Well if anything, we’re actually a little more up beat than what was projected in the budget.  This year’s budget was based on estimated GDP growth of 2.6% this year.  We actually think it will be close to the 3%.  We saw the economy end in 2009 with a bit of a flourish and that actually added in the 2010 with quite a bit of momentum and we think that some of that will carry through this year.  Admittedly, a lot of that momentum is being driven here at home by the incredible rebounding in the Canadian housing and also by a nice come back in Canadian consumer spending.  To really maintain that growth, we need the rest of the world and the US economy in particular to show a bit more room.  But we think the recovery will expand and take firmer root as we go through 2010.  I frankly believe that the budget’s forecast, if anything, will prove a bit cautious this year and next.  To me the bigger question is, you know, what happens after 2011, does that recovery really continue to expand and take a firmer route. And to me, that’s still a little bit of an opened question whether the US economy can really see a healthy recovery than what we are seeing at this point.

Ian Portsmouth: Well entrepreneurs will be watching closely.  So Doug, thank you for joining the Business Coach Podcast.

Doug Porter: Thank you for inviting me.

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

Thanks for listening to this episode of the Business Coach Podcast. I hope you’ve discovered a few insights that will help you grow your business, and that you’ll download other episodes from, or iTunes. As always, you can drop us a line at I look forward to hearing from you, and until next time, I’m Ian Portsmouth, editor of PROFIT Magazine, wishing you continued success.

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