The Bank of Canada has long predicted that the Canadian economy would rotate away from the consumer sector as its growth leader. It looks like in 2019, it won’t have much choice – the consumer is about to step aside, whether the new leadership is ready or not.
The central bank’s quarterly economic update, released Wednesday, shows a sharp deterioration in the growth outlook for 2019. And many of the key factors involved – a slumping oil sector, a stumbling housing market, a continuing adjustment to higher interest rates, tepid wage growth – place this slowdown in the lap of the consumer.
The most glaring figure in the Bank of Canada’s new projections is its forecast for growth of gross domestic income this year: 0.9 per cent, less than half of 2018′s estimated growth. The major source for this slowdown, as the central bank spelled out in Wednesday’s interest-rate decision and quarterly Monetary Policy Report, is the sharp drop in global oil prices in recent months, which has hit Canada’s oil sector particularly hard. That income slowdown will inevitably include households – at a time when they already have a growing list of other headwinds to overcome.
The Bank of Canada noted that household consumption and housing investment “have been weaker than expected” anyway, as Canadians struggle to adjust to the impact of tougher regulations weighing on the housing market, as well as the central bank’s gradual increase of interest rates over the past 18 months as the economy has approached full capacity. All of this comes at a time when Canadian households are carrying near-record debt levels relative to their disposable income.
At least some of this, of course, was inevitable. The consumer sector has been carrying the Canadian economy for years, and this was by the central bank’s design; its period of low interest rates after the Great Recession was entirely meant to keep consumer spending flowing while a heavily battered economy made some very hard adjustments.
In the post-Great Recession years from 2010 to 2017, household consumption contributed two-thirds of Canada’s gross domestic product growth. In 2015 and 2016, as the Bank of Canada cut already low interest rates twice to support the economy in the face of the severe oil market collapse of that time, households accounted for essentially all of the country’s GDP growth.
But since the Bank of Canada started raising rates in mid-2017, the household contribution to the economic expansion has faded. In the first half of 2018, household spending contributed roughly half of GDP growth. In the third quarter – the latest quarterly data available – it provided only about one-third of growth. The Bank of Canada’s projections suggest that households will be lucky to contribute even that much to 2019’s gain.
Much of that relates to the impact of the oil slump, primarily on the country’s oil-producing regions. The Bank of Canada estimated Wednesday that this oil slowdown will have only about one-quarter of the effect on the overall Canadian economy that the 2014-2016 oil shock had, because the price decline has been smaller and the oil and gas sector has shrunk markedly since 2014. But for the people in (mainly) Alberta who will feel the impact directly, it’s notable that the Bank of Canada’s key interest rate, at 1.75 per cent, is more than a full percentage point higher than it was in mid-2015. Mortgage and debt holders there will be swimming against a stronger rate current this time.
The bank also said that persistent weakness in oil-producing regions after the 2014-2016 slump has been a major factor in the slow wage growth for the country as a whole, even before this latest downturn in oil prices. That trend looks likely to deepen as the impact of the oil decline ripples through the economy.
And while the central bank believes the oil-related slowdown is “temporary,” the cloudy consumer picture is about much more than just oil. It’s more than a bit unnerving that the Bank of Canada’s concerns about the housing sector have re-emerged.
On Wednesday, Bank of Canada Governor Stephen Poloz acknowledged that housing “is taking longer to stabilize than we expected,” and added that given the excesses that had built up in the overheated Toronto and Vancouver markets, “it is always difficult to judge where the market will stabilize once the froth has been removed.” Extended housing uncertainty is yet another reason for consumers to run for cover.
Of course, the central bank has long expected that consumer demand would eventually be replaced by business investment and exports as the main driver of economic growth. It continued to express that hope Wednesday, despite recent weakness, especially in trade, that has raised doubts about just how strong this new source of leadership will be. Unless this rotation kicks in, and soon, the Bank of Canada’s downgraded projections for 2019 might prove optimistic.