A research report from National Bank Financial economist Krishen Rangasamy highlights the dark side of the weak loonie.
The cratering domestic currency is likely to help export growth, but it makes corporate investment expensive – particularly in imported machinery – and the expected gains in manufacturing employment may not be in the cards.
In a perfect world, the Bank of Canada's efforts to weaken the domestic currency would create a virtuous economic cycle.
Rising non-energy exports would result in profits for companies, hiring and eventually corporate investment in new machinery to increase production levels to meet demand.
The newly employed would spend their wages, creating more wealth throughout the economy.
Mr. Rangasamy throws a wrench into this rosy scenario in the report released Thursday, suggesting that corporate investment will stay weak for a long time.
"The investment decline won't be isolated to the energy sector. Thanks to the sinking Canadian dollar, it's now more expensive for everybody to import capital goods. … There's plenty of downside for investment spending from here. If we're correct about the extent of the investment slump, that would equate not only to weak growth this year, but also to lower potential GDP growth for 2016 and beyond."
The chart below is a re-creation of one presented by Mr. Rangasamy to support his pessimistic view on Canadian capital investment.
It suggests that the loonie is a leading indicator for corporate investment – when the loonie falls, investment is likely to follow.
In the current environment, the sharp drop in the Canadian dollar paints a bleak picture of the future.
Importantly, there is a regional economic tug-of-war that is hidden by the chart – spending in the oil patch is falling rapidly while initial signs of manufacturing investment become evident.
The energy sector has accounted for about 40 per cent of the total capital investment for S&P/TSX Composite companies in recent years.
Budgets have now been slashed and investment in the industry has come to an abrupt halt.
At the same time, June economic data featured a surprisingly strong showing from exports as Canadian Manufacturing reports: "With the lower loonie, exports to the United States led the way, rising 7.1 per cent to $34.2-billion in June. … Exports grew in 9 of 11 [industry groups] measured by Statistics Canada, led by consumer goods."
The export strength in non-energy sectors suggests that while the scale of cuts in energy-sector investment currently dwarfs the gains in manufacturing and consumer-goods investment, the tide in overall corporate investment may be turning.
However, Mr. Rangasamy's analysis implies that the upside in corporate spending will be very limited in the short term. The domestic economic recovery will be delayed and Canadians may well be stuck with sluggish growth for at least the next 18 months.
Follow Scott Barlow on Twitter @SBarlow_ROB.