BMO Financial Group Economics DepartmentMay 3, 2004
Atlantic Canada Economic Outlook
Atlantic Canada Economic Outlook 20041
BMO Financial Group Economics DepartmentMay 3, 2004
North American Economic Context
Expansionary fiscal and monetary policies prompted a significant acceleration in US economic activity in the second half of the 2003. Key contributing factors included a robust housing sector and strengthening business investment in machinery. For the entire year, the US economy grew by 3.1%.
The US economy began 2004 on a robust footing, with manufacturing exhibiting a firming pattern and business investment gathering even more momentum. While recently showing some signs of an improvement, labour market conditions have remained soft, as firms boost output through productivity-raising capital spending rather than through hiring. Overall, the US economy is slated to grow by 4.7% for the year. This would be a significant improvement from the average annual increase of 1.9% during the previous three years. Further out, the expansion should temper to 3.9% in 2005 and 3.3% during the 2006-2008 interval.
After outpacing its US counterpart during the previous four years, the Canadian economy grew more slowly in 2003, with a real GDP gain of just 1.7%. Factors contributing to theslower rate of expansion included weak, halting US growth in the first half, a sharp rise in the Canadian dollar, the SARS outbreak, and the discovery of ‘Mad Cow’ disease. Towards the end of the year, however, the economy appeared to be embarking on a recovery path, with growth picking up to a pace near 4% in the fourth quarter from just over 1% in the third.
This year, strong results in resource-based sectors and home construction are being tempered by a manufacturing sector which is still coming to terms with a higher Canadian dollar. Thus, we expect the average pace of economic growth to rise only moderately to 2.6%. Looking further out, Canada’s economic performance should improve, with real GDP growth rising to an average of 3.4% during the 2005-2008 interval. As growth strengthens and excess capacity is used up, we expect the Bank of Canada to gradually raise interest rates. The 90-day t-bill rate is projected to rise from an average of 2% in 2004 to 3% in 2005 and to reach its ‘policy-neutral’ level of 4.5% by late 2006.
From its low point of just under 62 US cents in January 2002, the Canadian dollar rose rapidly, climbing 27% to its recent peak of 78.8 US cents in mid January of this year. Since its peak, the dollar’s value has eased to about US 73.5¢ (April 28, 2004). Looking through recent short-term gyrations, we expect the Canadian dollar to consolidate at around US 76 cents during the next couple of years.
Commodity Prices
During the past couple of years, commodity prices rose sharply, providing a healthy boost to Canada’s resource-based industries. This has been very important to sustaining economic growth in Atlantic Canada in a period of generally weak macroeconomic conditions in North America and adverse developments such as SARS, rising global terrorism, and extreme weather.
BMO Financial Group’s monthly Commodity Price Index, which tracks the progress of 19 commodities produced in Canada, rose 56% from a recent trough in January 2002 to March 2004. All major sub-categories recorded strong increases over that period: oil and gas surged 110%, metals & minerals climbed 42%, agricultural products rose 34%, and forest products increased 29%.
Tight market conditions for crude oil and products and for natural gas have raised energy prices to very high levels. While oil prices are not likely to remain at their current level in the upper-$30 range for US benchmark West Texas Intermediate (WTI), they are projected to remain high by historical standards. We expect the price of WTI to just edge down from an average of US$31.15/barrel in 2003 to US$30/barrel in 2004 and US$25 in 2005. Global production is growing strongly enough to return inventories of crude to comfortable levels, even with strong demand in Asia. However, concerns about gasoline refining capacity in the United States and supply risks associated with Middle East violence and political instability in Venezuela and Nigeria have kept the risk premium on oil very high. For their part, elevated natural gas prices reflect a fundamental shortage of the commodity in North America. Over the next several years, high prices will be required to “price out” some demand and validate the economics of major projects to expand the import infrastructure for liquefied natural gas and to build pipelines to access northern frontier supplies. High energy prices are supportive of existing and expanding projects offshore Newfoundland and Nova Scotia.
Within the metals & minerals sub-index, particularly strong gains were recorded for nickel (129%), copper (100%), and lead (71%). Aluminum recorded a significantly weaker gain (22%), held back by difficult conditions in end markets such as automotive and aerospace manufacturing. The sharp increase in nickel and copper prices stemmed from tightening global inventories of the commodities as the rebound in US economic growth and a very fast pace of expansion in Asia, particularly China, bolstered demand. Additionally, there have been a number of work stoppages at major mines and little in the way of new project development. More recently, metal prices retreated sharply as authorities in China indicated they might have to take even stronger measures to bring growth down to a more sustainable pace. Nevertheless, prices have remained relatively high and should remain strong over the next two years, given supply restraints and our expectations that global economic growth should improve. This is positive for the major mining project under development at Voisey’s Bay in Labrador.
Over the same period, forest product segments showed a more varied performance. Booming residential construction in North America sharply boosted the demand for panelboard and lumber. The price of oriented strandboard surged 240% to record-high levels, while lumber prices climbed 42%. However, the prices of market pulp and newsprint continued to labour under generally weak demand conditions and more-than-adequate inventories in North America. Rising consumption of pulp in China has allowed for a moderate rise in prices while buyers of newsprint have provided considerable resistance to price increases. Over the course of this year, improving global economic growth, the summer Olympics, and the US presidential election should raise the demand for and prices of newsprint. The improving price picture for market pulp and newsprint should provide some welcome relief for related mills in New Brunswick and Nova Scotia.
The agricultural sub-index has risen, as very tight global inventories of grains and oilseeds have run into periods of poor harvests and rising demand in the developing world. Although prices are likely to remain volatile, buffeted by changing forecasts of growing conditions, grain and oilseed prices should remain firm due to generally low inventories and rising global demand.
Atlantic Canada Overview
Atlantic Canada’s economy underwent a pronounced weakening in business conditions in 2003, when the pace of the region’s economic growth slowed to 2.8% from a Canada-leading 6.7% in 2002. Nevertheless, even with this slowdown, the region’s economy outpaced that for Canada as a whole by close to one percentage point. This relatively good growth performance for the Atlantic Canada region largely stemmed from strong market conditions in the natural resource sector, particularly for oil and gas and metal mining. Real output in the natural resources sector rose by close to 8%, following a 21% jump in 2002. The construction and business services sectors also recorded healthy growth rates in 2003.
In part, the downswing in the region’s growth in 2003 reflects one-time, special factors in Newfoundland and Prince Edward Island. Newfoundland’s economy received a huge boost in 2002 from the coming onstream of new oil from the Terra Nova field and from resolution of earlier production problems at Hibernia. PEI’s economic growth in 2002 was boosted by the return to normal growing conditions for the potato crop, following a drought-induced decline the previous year. However, aside from the special-factor impacts, the pace of economic growth also slowed substantially in Nova Scotia and New Brunswick. In Nova Scotia, growth fell to less than 1% -- the slowest pace since 1996 – reflecting production problems at the Sable Island natural gas field and the completion of construction of a drilling platform the previous year. New Brunswick’s economy fared better, with growth outpacing the national level, albeit well down from the previous year. While home-building and non-residential construction advanced sharply, a decline in exports held back overall growth in the province’s economy. For the Atlantic Canada region as a whole, very weak performance of the hospitality industry (accommodation and food) also contributed to lower economic growth in 2003. This reflected collateral damage from the SARS scare, the impact of the rising Canadian dollar, and terrorism-induced declines in both personal and business travel.
Looking ahead, we anticipate the region’s economic growth to moderate even further to an average of 2.5% over the 2004-2005 interval. That would be approximately half a percentage point below the expected national average. This further moderation in growth largely reflects anticipated developments in Newfoundland, where production of oil is expected to grow more slowly. Conditions in the other three provinces should actually strengthen moderately. The manufacturing and tourism sectors should benefit from a stronger North American economy and adjustments by both producers and consumers to the higher level of the Canadian dollar. Major oil and gas, metal mining, and infrastructure projects should keep construction and overall business investment on a growing track. The half percentage point gap between the Canada and Atlantic Region’s expected growth during the next couple of years reflects differing profiles of population growth. The population in Atlantic Canada has actually been edging down at an average annual pace of 0.1% during the past four years, while that for Canada as a whole has been rising 1%. Thus, on a per capita basis, our projections show average growth in the Atlantic Canada of 2.6%, compared to 2% for the country as a whole.
Atlantic Canada Economic Outlook 20041
BMO Financial Group Economics DepartmentMay 3, 2004
New Brunswick
The New Brunswick economy is expected to continue expanding at mid-speed in 2004, reflecting mixed results among sectors.
In 2003, the pace of activity slowed considerably, although it still exceeded the national average. The first decline in exports since 1991 represented the biggest drag on overall performance. The sharp rise in the Canadian dollar, weak US demand through the early part of the year, and tough market conditions for many commodities important to the province all negatively affected the external sector.
Deterioration in the labour market – employment fell in the year – also contributed to dampening economic activity in 2003. However, the impact on consumer spending has been, fortunately, minimal. Strong growth in services expenditures more than offset a decline in durable goods purchases.
The main area of strength in the province has been capital investment. On the residential side, the hottest housing market in 20 years kept home builders and renovators very busy. On the non-residential side, highway construction and the refurbishing of the Coleson Cove power plant provided much of the impetus behind a strong rebound in investment, after three years of decline.
The main positive factor for the provincial economy in 2004 will be an expected turnaround in the external sector. With the Canadian dollar projected to remain stable, the stronger US economy and improved world commodity markets should boost demand for New Brunswick exports.
Also supporting overall growth this year will be continued work on large capital projects. A recent Statistics Canada survey indicated that capital spending intentions are up nearly 10% in 2004, the second highest growth rate among provinces, after Newfoundland and Labrador.
On a less positive note, advances in consumer spending are expected to moderate. Smaller gains in labour income following surprisingly strong increases in 2003 (given the weakness in employment) are projected to dampen domestic demand. Housing starts are also forecast to moderate from their 20-year high in 2003.
Finally, the fiscal situation will impose a drag on the economy. The recent 2004 provincial budget called for spending restraints in order to keep the balance in the black. The government plans to freeze public service wages and cut employment (by about 750 positions). Overall, a $54 million surplus is projected for the 2004-2005 fiscal year, after a $123 million deficit in 2003-2004.
All considered, economic growth in 2004 is projected to remain little changed from 2003, up marginally by 0.1 percentage point to 2.7%. This rate of expansion is seen to be only minimally surpassed in 2005.
Nova Scotia
The Nova Scotia economy is expected to rebound in 2004 from a poor performance in 2003. Still, projected growth this year remains well short of the national average.
In 2003, Nova Scotia ranked last among provinces in economic growth, as overall activity was adversely affected by declines in natural gas output, exports, manufacturing activity, and business investment. Lower volumes of natural gas production reflected maintenance work at offshore facilities and smaller reserve estimates of existing gas fields off Sable Island. Exports fell for the first time since 1995, hit by weak US demand in the first part of the year, the rise in the Canadian dollar, and softer conditions experienced by a number of key industries, including tire manufacturing.
The drop in exports weighed heavily on the manufacturing sector. The effect was compounded by a steep fall in shipbuilding activity, following the completion of a drilling platform in 2002.
Business investment softened as a result of a sizable drop in capital spending on machinery and equipment. Solid performance by residential construction – with housing starts reaching a 12-year high – and sustained demand for non-residential structures from energy project developers provided some offset. Damage caused by Hurricane Juan also contributed to boost reconstruction and repair work in the province.
The main drivers keeping the economy afloat in 2003 were steady growth in consumer spending and a rebound in public administration output. Total consumer spending was sustained by rapidly rising outlays on services. An increase in government program spending allowed the public administration to grow for the first time in three years.
The economic engine is expected to pick up steam in 2004, as natural gas production receives a boost from the entry into service of a new field – Alma – and as manufacturing exports benefit from stronger US demand.
Continued capital spending in the energy sector will fuel business investment. This should more than compensate for some slowing in housing starts. A Statistics Canada survey done earlier this year signaled an increase (albeit marginal) in capital spending intentions for 2004, after a decline in 2003.
Low interest rates and moderate growth in employment should continue to sustain consumer spending, although the rollback of part of a personal income tax (PIT) cut by the provincial government has made conditions less stimulative than earlier expected.
The cancellation of most of the 10% PIT cut, which came into effect only this past January, was the main feature of the 2004 provincial budget presented in April. It became necessary in order to ensure that the budget balance remains positive in the face of rising expenditures. Program spending in the 2004-2005 fiscal year is slated to rise quite rapidly, with health care receiving a substantial boost in funding. Community services also will get noticeably more. While the budget will remain in the black, the Nova Scotia government appears to have abandoned its tax cutting plans in favour of enhancing government services.
Overall, growth in the Nova Scotia economy is projected to bounce back to 1.9% in 2004 from 0.9% in 2003. While this would represent an improvement, it would not be sufficient to raise the province from the bottom of the provincial standings. Further improvement to 2.9% is projected for 2005. Actual performance could be even stronger if the Deep Panuke natural gas project goes ahead. The project has been on hold since 2002, while its economics were being re-evaluated.
Prince Edward Island
After a robust expansion in 2002 – largely reflecting a sharp recovery in crop yields – economic growth in PEI decelerated in 2003. The slowdown largely reflected a fall-off in tourism activity, weakness in agriculture, and a decline in exports. SARS, a stronger Canadian dollar, and uneasiness regarding travel combined to hamstring the tourism industry, with the number of visitors falling close to 4% in the year. The export sector was also hurt by the dollar’s strength, as shipments abroad were pulled down by a large decline in seafood
products. Additionally, farm cash receipts fell in the face of soft prices for some key products.
Still, the island economy outperformed its national counterpart in 2003, growing by almost 2% compared with 1.7% for Canada as a whole. Provincial economic growth was supported by improved conditions in construction. Driven by low interest rates and buoyant labour market conditions, home-building activity strengthened substantially, with housing starts climbing to a fourteen-year high of 814 units. Non-residential construction was also solid in 2003, partly reflecting capital expenditure on road building and repair, education- and health-related projects, and the building of manufacturing and hospitality facilities.