HIGHLIGHTS
- Fed, ECB, BoE remain on hold
- Canada loses 55,000 jobs in July
This week, there was a common feeling among central banks around the world: downside risks to economic growth are increasing. It was only a few weeks ago when inflation was the major concern for most central banks. But, while inflation risks still exist, there is mounting evidence that the global economy is slowing - perhaps much more than anticipated. As such, the central banks in the U.S., Europe and the U.K. all left interest rates unchanged this week, as they wait to assess the risks on each side of the equation.
Fed holds interest rates steady at 2.00%
The Fed's decision to leave interest rates unchanged at 2.00% was largely expected by financial markets. However, the communiqué that accompanied the decision hinted that the concerns over economic growth have intensified since the last meeting. Indeed, the Fed downgraded its view, stating that "downside risks to growth remain", whereas the previous statement stated that these risks had "diminished". The Fed once again highlighted softening labour markets, tight credit conditions, stress in financial markets, the ongoing housing contraction and elevated energy prices as the main sources of downward pressure on economic growth.
On the inflation front, while the Fed acknowledged the recent pullback in commodity prices and expects inflation to moderate later this year and next, it still believes upside risks to inflation exist. Personal consumption expenditure (PCE) figures released on Monday highlighted these risks, as headline PCE inflation jumped 0.8% in June - the fastest growth rate since 1981. Meanwhile, core PCE inflation accelerated to 2.3% Y/Y, up from the 2.2% Y/Y increase in May.
Nonetheless, the Fed's assessment is now balanced, with both the downside risks to growth and upside risks to inflation of "significant concern". Therefore, a rate hike in the near-term is highly unlikely. We expect the Fed to remain on the sidelines for the rest of the year, as it waits to see how the risks on each side of the scale play out.
Economic growth conditions deteriorate worldwide
After inflation concerns dominated the last European Central Bank (ECB) interest rate decision meeting, leading to a 25 basis point rate hike, economic growth in the Eurozone has since moved into the spotlight. ECB President Trichet stated that the current economic weakness was only "in part" expected and that downside risks are materializing - which is why the Bank decided to leave interest rates unchanged yesterday. Despite the likelihood that the Eurozone economy contracted in the second quarter and that, in our opinion, economic growth may bottom out later than the ECB currently expects, strong lending activity and high inflation levels will prevent the ECB from cutting rates until March of 2009.
The UK economy seems to be in an even worse position, as it is decelerating rapidly and is on the brink of slipping into a recession in the coming quarters. Still, inflationary pressures have kept the Bank of England (BoE) from cutting rates at the past two meetings. But, if oil prices continue to fall as we expect, a string of rate cuts by the BoE is a likely scenario - and could begin as soon as October.
In Japan, where a growing number of analysts have said the economy is in a recession, the Cabinet Office hinted that there may be some truth to this statement. In its August report, the office used the word 'weakening' - as opposed July's statement that the 'recovery is pausing' - to signal the end of a 6.5 year expansion period. While official judgment on whether or not the economy is in fact in a recession is done retroactively, a Cabinet official admitted that "there is a possibility that the economy has entered a recession".
Commodity prices lose steam
Mounting evidence of slowing or deteriorating growth in major economies has led to a significant pullback in commodity prices. This week, oil prices made headlines as they slipped below the psychological US$120 per barrel level on increased concerns over demand destruction. But it wasn't just oil - this week saw a slide in the commodity complex as a whole. Natural gas prices slid to a 5-month low, gold prices dropped to US$850, and most base metals prices also lost ground.
The drop in commodity prices certainly did not bode well for the Canadian dollar. After reaching parity with the greenback in September 2007 for the first time in over 30 years, and peaking in November, the Canadian dollar has stayed within a tight range of 97 US cents and US$1.03 - until this week. Indeed, the loonie broke through the 97 cent floor on Monday, hovering in the 95 US cent range throughout the week. And after this morning's employment report, the loonie fell even further, hitting 93 US cents. Given the fact that the Canadian dollar has cracked the floor that has been in place for the past nine months, and that we expect commodity prices to fall by 20% over the next 12 months, there is considerable risk that lower Canadian dollar levels could be in store.
Canada loses 55,000 jobs in July
Recent economic indicators in Canada certainly aren't providing any support for the loonie either. Indeed, after this morning's jobs report, it's safe to say that the boom in the Canadian labour market is over. Canada lost 55,000 jobs in July, following a loss of 5,000 jobs in June. The drop was widespread, with 8 of 16 sectors and 6 of 10 provinces posting declines. While Central Canada felt the brunt of the losses, western Canada was hit as well, with significant declines seen in Alberta and Saskatchewan. Perhaps the most shocking detail of the report - aside from the massive number of job losses - was the mass exodus of labour force participants (-74,000) which managed to drive the unemployment rate down to 6.1%.July's employment data undoubtedly shows underlying weakness in the Canadian economy. However, it is important to keep in mind that July is just one data point. Looking back, the employment sector in Canada has been quite astonishing this year. During the first quarter of the year when the economy actually contracted slightly, an average of 35,000 jobs were created. Hence, it was only a matter of time before some payback occurred. July's plunge brings the average monthly growth rate throughout 2008 down to 10,200 jobs - which is much more consistent with an economy expected to grow by 1.0%, and is a pace that is likely to continue for the remainder of the year.
Today's report, coupled with other data released over the past few weeks, shows that Canada is not immune from the global economic slowdown. Indeed, the Bank of Canada left interest rates unchanged at its last meeting as well, and given the current weakness in the economy, we expect it to refrain from hiking rates until the second half of 2009.
UPCOMING KEY ECONOMIC RELEASES
Canadian Housing Starts - July
Release Date: August 11/08 June Result: 216K TD Forecast: 210K Consensus: 210K
It is now becoming increasingly clear that the pace of Canadian housing market is slowing, as the pace of activity moderates to levels consistent with the longer-term trend, and more aligned with the current stage of the Canadian business cycle. And with tighter lending standards and a sluggish domestic economy, we expect this orderly moderation to continue into the coming months. With that in mind, Canadian housing starts should fall slightly in July to 210K, following the big drop the month before. Looking ahead, we expect Canadian housing starts to remain within the 200K to 220K range.
Canadian International Trade - June
Release Date: August 12/08 May Result: $5.5B TD Forecast: $6.0B Consensus: $5.8B
A weaker Canadian dollar and robust energy price gains in June are expected to provide the fuel for a modest boost in Canadian merchandise trade balance. Indeed, with energy prices posting a rather healthy 8.1% M/M gain and the Canadian dollar depreciating by 2% M/M during the month, we expect Canadian merchandise exports to rise a further 1.0% M/M in June, following the strong 5.4% M/ M in May. On the other hand, imports are likely to remain flat, following the 4.0% M/M gain a month earlier. However, with this improvement in the merchandise trade balance coming from price effects, the volume of exports will likely fall, due mostly to the weakness in the Canadian manufacturing sector.
U.S. Retail Sales - July
Release Date: August 13/08 June Result: total +0.1% M/M; ex-autos +0.8% M/M TD Forecast: total -0.1% M/M; ex-autos +0.4% M/M Consensus: total +0.2% M/M; ex-autos +0.6% M/M
As the impact of the tax rebate cheques wear off, we expect U.S. retail sales to come back down to earth in July. In particular, with the fiscal stimulus package having run its course, U.S. retailing activity is expected to moderate in the coming months as consumers pare back their spending as they buckle under the weight of the deteriorating labour market, declining home equity and tighter lending conditions. Moreover, the continued downward trajectory in motor vehicle sales (given the elevated level of fuel prices) will continue to weigh heavily on the overall retail sales number, though sales excluding automobiles are expected to post some modest gains. For July, our call is for total retail trade to fall by 0.1% M/M, while sales ex-autos are expected to rise by a modest 0.4% M/M.
U.S. Consumer Price Index - July
Release Date: August 14/08 June Result: core 0.3% M/M, 2.4% Y/Y; all-items 1.1% M/M, 5.0% Y/Y TD Forecast: core 0.2% M/M, 2.4% Y/Y; all-items 0.2% M/M, 4.9% Y/Y Consensus: core 0.2% M/M, 2.4% Y/Y; all-items 0.4% M/M, 5.2% Y/Y
The recent retreat in natural gas and gasoline prices in July will go some way in moderating U.S. consumer price inflation. During the month, we expect headline inflation to rise by a more modest 0.2% M/M, bringing the annual level of price increase to 4.9% Y/Y, following the multiyear high of 5.0% Y/Y reached in June. Core consumer prices are also expected to rise by 0.2% M/M, leaving the annual core inflation rate unchanged at 2.4% Y/Y. Moreover, with energy prices receding in the coming months and U.S. economic activity tapering off, we expect to see both inflation measures come back down from their current elevated levels.
Canadian Manufacturing Shipments - June
Release Date: August 15/08 May Result: +2.7% M/M TD Forecast: -0.2 % M/M Consensus: +1.0% M/M
Canadian manufacturing activity has shown some surprising resiliency in the past few months, with the sector posting fair-sized gains in four of the last five months. However, with a slowing Canadian economy and sluggish U.S. economic activity, we do not expect the fight-back to last much longer. Indeed, we expect a correction of sorts in the month of June, with monthly manufacturing shipments posting its second monthly drop this year with a modest 0.2% M/M drop. We believe that despite the favourable support coming from the weakened domestic currency, the medium to long-term profile for the Canadian manufacturing sector remains fairly weak.
The information contained in this report has been prepared for the information of our customers by TD Bank Financial Group. The information has been drawn from sources believed to be reliable, but the accuracy or completeness of the information is not guaranteed, nor in providing it does TD Bank Financial Group assume any responsibility or liability.
