Canada GDP in ‘Sweet Spot’ But Uncertainties Prevail

Bank of Canada Governor Stephen Poloz says Canada's economy has reached a point of near-perfect balance, with most companies running at full capacity and inflation nearing the central bank's elusive 2% target.

"We are at a point in the economic cycle that I think of as the "sweet spot", Poloz said in remarks prepared for a speech in Toronto. "We know that a majority of Canadian companies are running flat out," news outlets reported.

Poloz has often talked about this economic juncture as "home" and for the first time since becoming governor in mid-2013, he says Canada is nearly there. "We find ourselves quite close to home, and getting closer, with the economy now running close to full output and inflation expected to be around 2% later in 2018," he said.

Poloz also issued a warning to people who may be piling into high-flying bitcoin and other so-called cryptocurrencies, insisting they are not currencies at all. "The term 'cryptocurrency' is a misnomer–'crypto', yes, but 'currency, no'," he said. "For something to be considered a currency, it must act as a reliable store of value, and you should be able to spend it easily. These instruments possess neither of these characteristics, so they do not constitute "money."

The central bank has said previously that it is exploring the possibility of eventually issuing its own digital currency for retail transactions.

The Bank of Canada has raised its benchmark interest rate twice so far this year–to 1%. At that level, Poloz said rates remain "quite stimulative." And he vigorously defended the bank's decision not to be moving sooner to get its rate back to neutral, particularly with the economy at or near full capacity. The bank considers 3% to be the point where its key rate is neither speeding up nor slowing economic activity.

"We still see signs of ongoing, albeit diminishing, slack in the labor market," he said. "Fundamentally, this is an exercise in risk management."

Meanwhile, analysts from Wells Fargo, say: “Third quarter growth has slowed compared to the robust rates seen in the first half of the year. However, fundamentals suggest continued strength in the Canadian economy, with domestic demand remaining elevated, business activity continuing to improve and the unemployment rate currently sitting at a nine year low of just 5.9%,” FXStreet reported.

“Consumption appears to be leading growth, with business spending having bounced back this year, after declining in seven out of the eight quarters in 2015 and 2016. Similarly, consumer spending continues to expand. However, we have been cautioning that household debt levels in Canada are getting worryingly high, which could dampen future consumption.”

NAFTA Problems

The Bank of Canada is leaving the door open to further interest rate hikes in early 2018, making it clear that a number of uncertainties that could derail the economy, such as NAFTA renegotiation, are a reason for caution but not inaction.

Investors worry that terminating the North American Free Trade Agreement could hurt Canada’s economy and pressure its currency and a survey released on Friday by the nation’s export credit agency underscored those concerns.

Canada sends 75% of all goods exports to the United States and could be badly hit if Washington walks away from NAFTA, which Trump has blamed for American job losses and big trade deficits for his country, Reuters said.

The survey showed around 6% of Canadian firms could move part of their operations to the US as a way to cushion the potential blow.

But waiting for uncertainties, such as NAFTA renegotiation, to clear before raising rates again could add to imbalances in Canada’s economy, which has been boosted this year by a once red-hot housing market and the growing indebtedness of Canadians.

“Chances of a rate hike in January have increased to 36% from 30% before Poloz’s speech, the overnight index swaps market indicated.

The loonie, as the Canadian currency is called, rallied as much as 1.1% after the speech but has since given up those gains.

Other uncertainties that concern the Bank of Canada include tighter mortgage rules that come into effect in January, and how the economy will respond to the two rate hikes earlier this year, which took the benchmark interest rate to 1%.