Gradual recovery for Canada’s economy

An automotive employee works on an assembly line.

Going forward, the automotive sector will represent only 3% of Ontario’s economy.

With the Canadian economy showing signs of life, we asked Craig Alexander, Senior Vice President and Deputy Chief Economist at TD Bank Financial Group, for his thoughts on what the recovery will look like.

The Bank of Canada has announced that the recession is over. Is this accurate?

There’s no question that the economic contraction is in its final stages and that the Canadian economy might have actually grown in the third quarter of 2009.

What will the recovery look like?

We still expect a slow, gradual recovery with some mixed economic data in the short term. Indeed, for many Canadians, it might not feel like a recovery at all. That’s because the unemployment rate typically peaks about six months after the economy starts to grow, so people may still worry about jobs in the coming months.

There will be job creation in 2010; but as more unemployed workers re-enter the labour force to look for work, it will prevent the unemployment rate from declining significantly.

Since the economic recovery will be relatively gradual, we don’t see inflation as a problem. This means that the Bank of Canada will probably not have to start raising rates until at least the middle of next year, and the subsequent increase in interest rates should prove drawn out over time.

What’s the outlook for Canadian manufacturers?

Things will get better for companies that export their goods, but it will be a slow recovery. The higher Canadian dollar will make goods more expensive abroad — particularly in the United States. And we’re not going to see consumer spending in the U.S. rebound like it has in past downturns, which will also hurt Canadian exporters.

You mentioned a stronger Canadian dollar. Can you expand on the relationship between the loonie and the U.S. dollar?

One of the dominant themes to look for over the next decade is the erosion of the U.S. dollar. Over the short term, we believe the exchange rate will be higher than that expected by the Bank of Canada. The Bank of Canada assumes the dollar will average 87 cents U.S. next year, but TD Economics believes the average exchange rate will be in the mid-90-cent range.

Canadian companies will adjust to the stronger dollar. For them, the problem is not a long-term change in the value of our dollar; rather, the problems arise when the exchange-rate moves are too sudden, which makes it difficult for businesses to plan.

What are the prospects for commodities?

The lower U.S. dollar is good news for commodities producers because commodities are priced in U.S. currency. However, many commodities have already risen substantially from their lows. For example, oil and base metals have seen powerful rallies. Those rallies have anticipated future demand, but that hasn’t been reflected in real demand. We think commodities will still rise, but the gains will not be as strong as we have seen recently.

The housing market has held up reasonably well. Will this trend continue?

We saw surprising strength in the Canadian housing market in the spring, with strong sales and price increases. But the gains in housing prices may mean we’re stealing from the future. Buyers are getting into the market while interest rates are low. As we move into next year, we will probably see house prices rise at a mid-single-digit pace.

Are there any long-term structural changes stemming from the recent downturn?

I don’t think there have been any dramatic fundamental changes. The Canadian economy was more affected by external shocks than by internal developments. We didn’t have the deep structural problems that the U.S. experienced and that European countries such as the United Kingdom had to face.

The one area in which there has been fundamental change is the automotive sector. Before the recession, the auto sector represented about 5% of the Ontario economy. Going forward, it will represent only 3%.

Another structural change that could take place is with consumers. We’re seeing households increase savings rates, which in Canada had fallen to unsustainably low levels. Canadians just can’t continue to accumulate debt the way they have in the past, which means the trend towards thrift will continue.

What about the global economy? Are there fundamental changes there?

One of the lessons learned from this recession is that globalization has made the world economy even more synchronized and connected than people had imagined. Another dominant economic theme prior to the turmoil was the emergence of China, India, and other developing economies. These countries weathered the economic turmoil well and are emerging as strong economic powers. Indeed, China and India will exert greater economic influence, and countries such as Brazil are becoming more important.