Canada Caught in the Undertow

As a small open economy, Canada is not immune to the global recession. The deep contraction in US economic activity has been particularly challenging for Canada, given the countries’ trade ties. US auto sales dropped to an annualized rate of 9.1 million units in February, marking a 40 per cent year-over-year decline and the lowest activity on record. This contributed to declines of 30 per cent in the vehicle manufacturing components of Canada’s GDP in Q4 2008. Meanwhile, the US housing market has yet to turn the corner. New home starts have tumbled to historical lows while home prices continue to trend lower, suggesting further challenges for Canada’s wood products sector. A global pull-back in economic activity has also lowered the demand and price of a number of other Canadian export commodities, including those in the metals, minerals and energy sectors.

While the retrenchment in export activity has dominated headlines, domestic demand has also weakened. Personal spending fell for the first time since 1995 in Q4 2008, reflecting lower consumer confidence and less robust labour market conditions. Investment has also slowed in plant and equipment, and residential structures. The latter reflects less new home construction, renovations, and real estate transfers.

As a result, Canada’s GDP contracted at an annualized rate of 3.4 per cent in Q4 2008, the weakest quarterly performance since 1991 (Fig.2). That said, this decline paled in comparison to those recorded in regions such as the US, Euro Area and Japan.

A weaker Canadian dollar has and will result in higher import prices. Even so, a contracting economy with excess capacity will continue to exert downward pressure on inflation (Fig.3). This will provide the Bank of Canada room to further cut its policy interest rate to spur economic activity. Expectations of lower inflation and future interest rates will push interest rates lower on longer-term products, such as mortgages.

“Copyright British Columbia Real Estate Association. Reprinted with permission.”