Two BMO economists were in Vancouver last week speaking to clients and sat down with Business in Vancouver for a chat about the Canadian economy.
Doug Porter, BMO Financial Group chief economist, and Lesley Marks, chief investment strategist for BMO Private Banking, spoke about the North American Free Trade Agreement (NAFTA), the U.S.-China trade war, a rising Canadian dollar, normalization in the housing market and the Trans Mountain pipeline.
Q: Oil prices and the Canadian dollar are both up. To what degree are oil prices responsible for a stronger Canadian dollar?
Porter: I think it is fair to say that the comeback in oil in the last month or so, and especially the comeback in Canadian oil prices, have played a role in supporting the Canadian dollar. But I think another very important factor at play recently is just the outlook generally on NAFTA is much less negative than it was, say, around the turn of the year. I do think there was a bit of a discount on the Canadian dollar. I’d almost call it a NAFTA discount.
Q: For some sectors, like exporters, a low dollar is an advantage. What is the upside to a stronger Canadian dollar?
Porter: When a currency strengthens, generally speaking consumers win and most producers tend to suffer a little bit. But from a bigger-picture standpoint, I think having the currency appropriately valued is good for everyone at the end of the day. And I happen to believe that something close to $0.80 is not far from fair value for the Canadian dollar.
Q: From an investment point of view, what is the anxiety level of investors right now over NAFTA?
Marks: With President [Donald] Trump’s clear pivot toward China and away from NAFTA, we do have some relief in the whole perception around the impact or the potential negative impact on NAFTA.
This is a case where you could actually see … if we did see a resolution to the negotiations on NAFTA, where the Bank of Canada could potentially use that resolution as a catalyst to increase interest rates. The Bank of Canada has identified that [failure to renegotiate NAFTA] as a major risk for the Canadian economy. But another major risk is also related to rising interest rates and the impact that that could have on consumers, not just in housing and mortgage loans but just in general consumer loans.
Q: Does the trade war that is developing between the U.S. and China work to our benefit in providing a distraction?
Porter: I think it’s fair to say that the U.S. doesn’t want to be fighting two serious battles at once, and China’s a much bigger issue for the U.S. And I also happen to believe that there are some voices around Mr. Trump telling him that NAFTA’s not really the enemy that he portrays it as. I think he personally does not like NAFTA … but I think that there are enough voices around him that have led him to basically train his fire elsewhere.
Q: Business investments in Canada have been much lower than one would expect when the economy is doing well. Why are businesses not investing and reinvesting in their businesses?
Marks: I think that the real issue in Canada is a lack of diversification in our sources of economic growth. We’ve seen strong growth and related growth on the consumer side, as it relates to … housing prices. And to sustain growth into the future for the Canadian economy, we need to see greater diversification in our economy, including the development of entrepreneurial industries as well as export industries.
So I think it’s going to be important for policy-makers both at the federal and provincial level to consider that our economy needs to be more greatly diversified to have sustainable growth, and also to be able to compete with our trade partners to the south, where the tax environment has become much more favourable for investment.
Q: We have been hearing about a “real-time” flight of capital from Canada. Now Ottawa may financially backstop the Trans Mountain pipeline project. Is this not a signal to the international investment community that not even the Canadian government has enough confidence in Canada as a place to invest, that it now has to take a public stake in a project?
Porter: Obviously it is a bit of a black spot on Canada from an investor’s standpoint. We’ll have to see how exactly it unfolds, but I think probably the wider view would be that this is a rather specific set of circumstances and doesn’t necessarily speak to investment projects across the country.
Frankly, I was a little bit concerned about Canada’s investment climate even before this moved right back onto front and centre as an issue. We saw a big net direct investment outflow in 2017 – the largest on record – and that was even before all the concerns over the Trans Mountain pipeline really came back to the fore.
Q: We have recently seen some big declines in housing sales, but that is in comparison to a very overheated 2017. Are we starting to see some normalization in the Canadian housing market?
Marks: We are seeing some level of normalization, and in addition to some market-specific policies, we have policies in place now that test the sensitivity of mortgages to higher interest rates, which is very key to removing certain levels of speculation.
I think that’s important, that investors in Canadian real estate are stress-tested, because we’ve been very successful as a country in enduring different crises in the past, but in particular the great financial crisis in 2008. We didn’t endure the same problems that they experienced in the U.S., and part of that is because of our policies. We want to continue to have a strong financial sector going forward. That’s such an important part of the Canadian economy. •
