Canada’s economy set to improve on the back of increased external demand: RBC Economics

Stronger external demand and the benefits of a more competitive Canadian dollar lifted Canada’s exports in the second quarter of 2014, lifting overall economic growth from weather-related weakness early in the year. This trend is expected to continue to lift GDP growth, according to the latest Economic and Financial Market Outlook issued today by RBC Economics. RBC projects real GDP growth of 2.4 per cent in 2014 and 2.7 per cent in 2015.

The strength in exports was not just an energy story. Canada’s non-resource goods and non-energy commodities posted sharp increases in the second quarter of 2014, following large declines during the recession. Both sectors have taken much longer to recover than the energy sector where exports stand 27 per cent higher than their pre-recession peak. RBC anticipates that in the months ahead, exports outside of energy – such as autos, chemicals, aircrafts, industrial machinery and electronic machinery – to maintain the improved momentum seen in Q2.

“The shift to external demand will allow the economy to grow at a solid clip, despite expectations that high levels of household debt will limit growth in consumer spending and affordability strains will slow housing market activity,” said Craig Wright, senior vice-president and chief economist. “On the upside, the strengthening external demand will likely motivate Canada’s businesses to increase their pace of investment and hiring.”

With the economy entering a period of above-potential growth in the second quarter, RBC expects the output gap to narrow and labour market conditions to tighten. Tightness in the labour market will result in a recovery in full-time employment and in time, exert upward pressure on wages. The unemployment rate is expected to end 2015 at 6.5 per cent.

The outlook for consumer spending is that it will grow at trend rate of 2.3 per cent with support from a record level of net wealth. RBC says that increases in interest rates will be gradual and occur as income growth accelerates, which should allow consumers to absorb increases in debt service costs.

RBC says that the Bank of Canada’s economic forecast is predicated on similar expectations that drivers of growth will broaden.

“Improved second quarter export growth signals that the shift in drivers of growth is underway, but until there is evidence that the shift is sustainable, the Bank is likely to maintain its policy stance,” said Wright. “We expect demand for exports to accelerate this year prompting the Bank to re-establish a tightening bias though policymakers will hold the overnight rate at 1.0 per cent until the second quarter of 2015.”

The report states that one area of the economy that has proven surprisingly resilient has been the housing market with sales fully recovering from the weather-induced dip this winter, thanks in large part to lower mortgage rates. This year, RBC anticipates resales to increase by 2.1 per cent with prices posting a hefty 4.3 per cent gain. Next year, as rising interest rates intensify pressures on affordability, resales are likely to ease with price gains slowing to 1.1 per cent.

After three months of steady appreciation, the Canadian dollar reversed course in August, which RBC says was more a function of U.S. dollar strength than any made-in-Canada factor.

“With the U.S. dollar expected to appreciate further in 2015 as the economy strengthens and official interest rates begin to rise, another round of weakening in the Canadian dollar is likely,” said Wright. “The currency will drop to 0.87 U.S. cents this year and 0.85 U.S. cents in 2015.”

The provincial economic picture this year continued to show a stark contrast between the booming conditions in Alberta and a much more subdued state of affairs pretty much everywhere else.

“We anticipate strengthening U.S. demand will drive further export gains across provinces next year and lead to widespread improvement in provincial growth prospects,” said Wright. “Alberta will continue to top our provincial growth rankings in 2015 though we do see the other provinces narrowing the gap.”

A complete copy of the RBC Economic and Financial Market Outlook is available as of 8 a.m. ET. A separate publication, RBC Economics Provincial Outlook, assesses the provinces according to economic growth, employment growth, unemployment rates, retail sales, housing starts and consumer price indices.