Bank of Canada dovish on Western friends, positive on China

On September 7th the Bank of Canada issued a report concerning the dutch disease; with Governor Carney's remarks intended to ease concerns about the high Canadian dollar's adverse effect on trade sensitive sectors. However, the report failed to address how policy makers will respond to Canada's growing troubles in manufacturing productivity and inflated housing sector. Instead, the report shared some insightful information on the BoC's negative outlook on the US and Europe. Canada is strategically aligning its economy to meet the long term resource demands of the emerging world, most notably from China.

Canada's global projections are on point and deserve greater attention. It is in Canada's best interest to remain well informed about the global economy.



Dutch disease occurs when a high currency value creates resource specialization in one sector, while hurting other trade sensitive sectors. In Canada high commodity prices have increased the value of the Canadian dollar which helps with resource exports but makes manufacturing exports more expensive, thus less attractive to global demand. Canadian manufacturing productivity is on the decline and the job pace has slowed down considerably. BoC Governor Carney argues that the economy is well diverse and strategic policies (left unmentioned) will help minimize the adjustment costs.

The BoC's economic outlook on its Western friends remains dovish. For the US, Canada provided some indication for further stagnation to 2015; hence the Fed decision to extend its guidance to 2015. This supports to the idea that the US economy will likely remain in a slump even beyond the estimated point of recovery.

"Bottom line, with less capital investment and more structural unemployment, the [Bank of Canada] estimates that the US economy will remain over $1 trillion smaller in 2015 than we had projected prior to the crisis."

For Europe, the BoC is even more dovish. The Bank states that structural reforms are in desperate need, but austerity could lead to serious consequences. Austerity will lower wages, decrease demand, increase unemployment, and lead to tight credit conditions. Although BoC welcomes the ECB plan, it was quite amusing that the country's Finance Minister Jim Flaherty slipped and said "I'll believe it when I see it" in the prior week.

"Europe is unlikely to return to its pre-crisis level GDP until a full seven years after the start of its last recession"

This could mean that Europe's continued problems could place a damper on the US economy beyond 2015. Furthermore, the BoC believes that Europe has a clear balance of payment crisis with debtor countries on the periphery under intense pressure to repay creditors by regaining competitiveness.

With demand prospects of its Western friends declining, Canada has found a bright spot in China. The BoC expects an average growth rate of 7.5% in China, which should remain stable in the next few years. As China works to foster a growing urbanized middle-class, resource demand will escalate and compensate for the decline in the West. The BoC states that Chinese policymakers are taking appropriate measures to reign in its economy to promote sustainable domestic growth. However, China is experiencing an export slow down due to lower European demand. The problems in the West will continue to strain global growth despite the quick turnaround in the emerging world.

Lastly, the BoC expects volatile commodity prices, albeit elevated. Canada's over reliance on hard resource exports might prolong its domestic woes. Mining, construction, and logging/forestry continue to lead its economy, with capacity utilization improving. However, housing prices are still positive, but decreasing; expect to see housing prices touch negative territory soon. A housing peak, manufacturing unemployment, and greater household debt, are some of the main problems that must be corrected. The report merely calls for greater capital investment and promoting skills to compete. The evidence that has long been glossed over deserves greater attention. The dutch disease is real*, but the BoC's response was mediocre.

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*After the US Fed's QE3 announcement, the Canadian dollar rallied to a one year high. However, the disappointing July manufacturing survey reinforced Dutch Disease fears and triggered a decline in the Canadian dollar on Friday despite post-QE3 risk-on sentiment evident in the market. The underlying data actually showed that lower  transportation sales  (after four consecutive months of increases) were largely responsible for the overall drop.