Implications of the Coronavirus for the Canadian economy
With the risks surrounding the Coronavirus/COVID-19 outbreak escalating, we would like to share our current thinking regarding the Bank of Canada (BoC) and the outlook for the Canadian economy. We will highlight what we had forecast entering 2020, how the economy was evolving prior to the outbreak and the potential implications going forward.
What we said were the key watch points for 2020:
In our 2020 Global Market Outlook, we discussed Canada’s precarious position. Our view at the time was more cautious than that of the BoC's view on three fronts:
- Inflation: We believed Canadian inflation had more downside risks
- Investment: Canadian business investment would not rebound as vigorously
- Debt: Canadian households overburdened with debt would hold back on consumption, despite a resurgent housing sector
Our conclusion, therefore, was that these vulnerabilities would force the BoC to cut its overnight target rate twice by the end of 2020.
Macro backdrop pre-COVID-19:
Taking stock of the economy prior to the coronavirus outbreak reveals that consumption and housing underpinned domestic strength. Related to the former, the labour market report from Friday, March 6, was encouraging. The Canadian economy added 30,300 jobs for the month of February 20201: at least at the onset of the coronavirus crisis, employment was stable. On the latter, the housing sector has benefited from declining interest rates - which had been trending lower prior to the virus outbreak.
Outside of housing and consumption, however, economic fundamentals2 have been less encouraging. In particular, manufacturing and exports have been struggling. Manufacturing sales have declined for four consecutive months, while exports have contracted in four of the previous five.3 Importantly, as the chart below shows, yearly economic growth in Canada has been trending lower for some time now. The year on year growth as of the fourth quarter of 2019 was an unimpressive 1.47%.
Source: Refinitiv DataStream, Russell Investments. As of 4Q2019.
Post COVID-19 outbreak
The COVID-19 outbreak serves as a stark reminder of how quickly financial conditions can pivot due to exogenous shocks. The Canadian economy recently has been hobbled by rail blockades, auto plant shutdowns and persistent pipeline constraints. Add to that list the plunge in the price of oil on March 9 as a price war escalates between Russia and Saudi Arabia. Clearly the margin of safety was limited - and now the virus outbreak, coupled with collapse in oil prices, has exacerbated the downside risks to the Canadian economy, as well as the global economy at large.
Global policy makers have not been standing by idly. G7 finance ministers have communicated a coordinated message of support. Moreover, a quasi-coordinated response from global central banks is emerging. On March 4, The BoC cut its overnight policy rate by 50bps to 1.25%, matching the recent rate cut by the U.S. Federal Reserve. The Australian Reserve Bank also cut its policy rate by 25bps.4
Specific to Canada, there may be more support coming. In the statement accompanying the BoC policy meeting last week, the Bank noted the "Governing Council stands ready to adjust monetary policy further if required to support economic growth and keep inflation on target"5, a clear indication that further easing is likely.
Our forecasted range for Canadian GDP (gross domestic product) growth in 2020 was 1.0% to 1.5%. A weak economic environment over the first quarter, and perhaps over the first half of 2020 means the odds are skewed towards the lower end. That said, we acknowledge the situation is exceptionally fluid and it would be foolish for us to draw any definitive conclusions as we do not have any edge or unique ability to forecast the progression of this outbreak. We do know, however, that policy makers have a watchful eye on its progression and have thus far been pro-active in responding.
1 Source: Refinitiv DataStream
2 Source: https://business.financialpost.com/news/economy/bank-of-canada-believes-rate-cut-will-bolster-housing-market-not-fuel-froth-as-economic-picture-darkens
3 Source: Refinitiv DataStream
4 Sources: https://www.federalreserve.gov/newsevents/pressreleases/monetary20200303a.htm,
5 Source: https://www.bankofcanada.ca/2020/03/labour-market-canadas-resilience