GDP to remain below pre-virus trend for years - Capital Economics
Canada Economics

GDP to remain below pre-virus trend for years

Canada Economic Outlook
Written by Stephen Brown

Canada’s relative success in containing the virus so far and the generosity of government income support suggest that the initial rebound in consumption will be stronger than we previously anticipated. But weak external demand and low commodity prices imply that exports and investment will lag. GDP is set to fall by 6.3% this year and our forecast for a 5.5% rebound in 2021 implies that it will remain below its pre-virus level until early 2022. Against that backdrop, we expect the federal budget deficit to remain wide and think the Bank of Canada will continue its asset purchases for at least another 12 months.

  • Overview – Canada’s relative success in containing the virus so far and the generosity of government income support suggest that the initial rebound in consumption will be stronger than we previously anticipated. But weak external demand and low commodity prices imply that exports and investment will lag. GDP is set to fall by 6.3% this year and our forecast for a 5.5% rebound in 2021 implies that it will remain below its pre-virus level until early 2022. Against that backdrop, we expect the federal budget deficit to remain wide and think the Bank of Canada will continue its asset purchases for at least another 12 months.
  • External Demand – After being hit similarly hard in the first half of 2020, we expect the recovery in exports to lag imports. Exports are unlikely to do well so long as global investment and energy demand remains weak, whereas there is scope for imports to rebound more quickly alongside the recovery in consumption. Accordingly, net trade will subtract from GDP this year and next.
  • Domestic Demand – The larger-than-expected payout to households from the Canada Emergency Response Benefit has led us to revise up our forecast for consumption, although we still expect it to remain below pre-virus levels until the second half of 2021. We expect residential investment to rebound relatively strongly, but non-residential investment is likely to lag given high levels of spare capacity and low commodity prices.
  • Inflation – We expect an average of the Bank of Canada’s three core inflation measures to bottom out at near 1.5% in the coming months. While subdued demand is likely to keep core inflation below 2% over the next few years, a rebound in gasoline prices means that headline inflation should average close to 2% in 2021 and 2022.
  • Monetary & Fiscal Policy – The magnitude of the coronavirus shock leads us to think that the federal government will run a deficit of 14% of GDP this calendar year and that the Bank of Canada will continue its asset purchases beyond the end of 2020. We expect the deficit to remain wide in 2021, at 7% of GDP, and do not anticipate any interest rate hikes in the next few years.
  • Long-Term Outlook – High private-sector debt is likely to hold back productivity growth in the coming decade relative to that in the US. And with the ageing population keeping a lid on labour force growth, we expect potential GDP growth to be just 1.5% from 2025-30, compared to 1.8% recently. From 2030, we expect potential growth to start rising again as productivity growth rebounds.

Key Forecast Table

Table 1: Key Canada Forecasts

% q/q annualised

2020

2021

2022

Annual (% y/y)

(unless otherwise stated)

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

2020

2021

2022

 

Demand

 

GDP

-8.2

-40.0

35.0

15.0

5.0

3.0

2.7

3.1

3.5

3.8

4.1

4.1

-6.3

5.5

3.5

Final Consumption

-7.5

-35.2

26.9

25.5

3.0

2.7

2.7

2.7

2.4

2.4

2.4

2.5

-4.9

6.3

2.5

– Household Consumption

-9.0

-47.8

36.0

36.0

3.2

3.2

3.2

3.2

3.2

3.2

3.2

3.2

-7.6

7.6

3.2

– Government Consumption

-3.8

9.1

8.2

4.1

2.4

1.2

1.2

1.2

0.4

0.4

0.4

0.4

2.5

3.4

0.7

Private Fixed Investment

-1.4

-52.1

42.7

21.0

5.5

4.6

2.5

3.1

3.4

4.4

4.9

4.9

-7.7

6.1

3.8

– Business Fixed Investment

-2.1

-46.9

31.1

11.8

6.5

5.0

3.7

4.6

5.1

6.9

7.6

7.6

-8.8

4.7

5.6

– Machinery & Equipment

-13.1

-59.0

57.4

12.6

12.6

8.2

4.1

7.0

8.2

10.4

12.6

12.6

-16.6

7.6

8.7

– Non-Residential Structures

4.1

-47.8

26.2

12.6

4.1

4.1

4.1

4.1

4.1

6.1

6.1

6.1

-6.0

3.4

4.8

– Intellectual Property

1.0

-11.5

8.2

8.2

4.1

2.0

2.0

2.0

2.8

2.8

2.8

2.8

-1.6

3.5

2.5

– Residential Investment

-0.4

-59.0

63.0

36.0

4.1

4.1

0.8

0.8

0.8

0.8

0.8

0.8

-6.0

8.1

1.0

Government Fixed Investment

4.6

-18.5

12.6

8.2

4.1

4.1

4.1

4.1

4.1

4.1

4.1

4.1

-0.3

4.2

4.1

Final Domestic Demand

-6.0

-37.9

28.8

24.0

3.4

3.0

2.7

2.8

2.7

2.8

2.9

2.9

-5.2

6.2

2.8

Exports

-11.3

-31.4

12.6

6.1

4.1

4.1

4.9

4.9

5.3

6.6

7.0

7.0

-8.2

3.0

5.6

Imports

-10.7

-28.4

21.6

14.8

6.1

4.1

2.8

3.2

3.2

3.2

3.2

3.2

-6.4

5.8

3.2

 

Labour Market

     

 

     

 

     

 

     

Unemployment Rate (%)

6.3

12.6

9.6

8.8

8.5

8.1

7.8

7.5

7.1

6.8

6.5

6.2

9.3

8.0

6.6

Employment (%y/y)

-0.4

-12.4

-6.9

-5.2

-2.6

11.3

4.8

3.4

2.6

2.3

2.1

1.8

-6.2

4.3

2.2

 

Prices (%y/y)

                             

Consumer Prices

1.8

-0.2

0.5

0.7

1.2

2.5

1.8

1.9

2.0

1.9

2.0

1.9

0.7

1.9

1.9

Core Consumer Prices1

2.0

1.7

1.4

1.4

1.5

1.5

1.5

1.6

1.7

1.7

1.8

1.9

1.6

1.5

1.8

 

Markets (end period)

                             

Overnight Target Rate (%)

1.75

0.25

0.25

0.25

0.25

0.25

0.25

0.25

0.25

0.25

0.25

0.25

0.25

0.25

0.25

10 Year Gov’t Bond Yield (%)

0.71

0.55

0.65

0.75

0.75

0.80

0.85

0.85

0.90

0.90

0.95

1.00

0.75

0.85

1.00

CADUSD Exchange Rate

0.70

0.73

0.74

0.75

0.76

0.77

0.79

0.80

0.81

0.81

0.82

0.82

0.75

0.80

0.82

 

Other

                             

Current Account (% of GDP)

-1.9

-2.9

-3.1

-3.6

-3.7

-3.6

-3.4

-3.3

-3.1

-2.9

-2.6

-2.3

-2.9

-3.5

-2.7

Federal Budget Bal. (% of GDP)

-14.0

-7.0

-3.0

 

1 CPI-trim. Sources: Refinitiv, CE


Overview

GDP to remain below pre-virus trend for years

  • Canada’s relative success in containing the virus and the generosity of government income support suggest the initial economic rebound as the country re-opens will be stronger than we first thought. GDP is still set to fall by 6.3% this year, however, and our forecasts imply it will remain below its pre-virus level until early 2022.
  • As things stand, Canada appears to have done a better job at containing the coronavirus than its southern neighbour, with the number of new cases per million people averaging nine each day at the start of July, compared to the renewed rise to 150 in the US. (See Chart 1.) That may partly reflect the later re-opening of the economy in Canada, although employment and hours worked nevertheless started to rebound in May, as the most severe restrictions were lifted. (See Chart 2.)
  • While employment remained 14% below its February level in May, we are more optimistic than we were three months ago about the outlook, thanks in part to the expansion of the Canada Emergency Response Benefit (CERB) which means it seems to have more than offset lost labour income. (See Chart 3.) Moreover, given the ease at which the minority government passed a two-month expansion of CERB, we are now assuming some form of expanded income replacement will remain in place for as long as needed. We would be surprised if eligibility remained as generous as it is now, but an extension should prevent household income falling by much, if at all.
  • The re-opening of the economy has helped consumer confidence rise in recent weeks, and the CFIB Business Barometer has rebounded by even more. Nevertheless, it remains consistent with a sharp fall in non-residential business investment. (See Chart 4.) The outlook for the energy sector looks particularly poor given the likelihood that demand for travel, and therefore fuel, will remain subdued for years. Our forecast for oil demand across the Americas implies energy exports will remain below their pre-virus level over the next two years. (See Chart 5.)
  • Policymakers have recognised the gravity of the situation and acted accordingly, with the federal government likely to run a budget deficit in the region of 14% of GDP this calendar year and the Bank of Canada slashing rates to 0.25% and expanding its balance sheet by $180bn, or 7% of GDP. (See Chart 6.) We expect the Bank to continue its asset purchases for at least the next 12 months. We assume that the government will announce some form of infrastructure spending plan soon, which will mean the deficit remains relatively wide at 7% of GDP in 2021.
  • Even with that support, our new forecasts imply it will still take until early 2022 for GDP to return to its pre-virus level, and that GDP is unlikely to return to its pre-virus trend until 2023 at the earliest. (See Chart 7.) Moreover, if the latest outbreaks in the US get much worse, or there are new outbreaks in Canada, we would have to pull our forecasts down.
  • Although output is set to remain below its potential for the next three years, we suspect that core inflation will soon bottom out at close to 1.5%. Subdued demand will further lower inflation for some items including rent and mortgage costs, but the costs associated with operating in the COVID-19 environment suggest that inflation for other items will start to rise. We doubt that core inflation will surpass 2% within our forecast horizon, but the partial rebound in oil prices suggests headline inflation may briefly hit 3% in 2021. (See Chart 8.)

Overview Charts

Chart 1: New COVID-19 Cases per Million People
(7-day average)

Chart 2: Employment & Hours Worked

Chart 3: CERB Payments & Lost Income
(March to May, $bn)

Chart 4: CFIB Business Barometer & Investment

Chart 5: US Oil Demand & Oil Exports

Chart 6: Bank of Canada Assets ($bn)

Chart 7: GDP ($bn)

Chart 8: CPI Inflation (%)

 

Sources: Refinitiv, Bloomberg, Capital Economics


External Demand

Exports to lag imports

  • After being hit similarly hard in the first half of 2020, we expect the recovery in exports to lag imports. Exports are unlikely to do well when global investment and energy demand remain weak, whereas there is scope for imports to rebound more quickly alongside the recovery in consumption.
  • Despite a modest rise in goods exports in May, they remained 29% below their February level, while goods imports were 30% lower. (See Chart 9.) Plant closures and the sharp fall in demand for big-ticket items means that trade in autos, aircraft and other large-scale equipment has fallen the most. (See Chart 10.) The outperformance of exports in May nevertheless drove the goods trade deficit to its narrowest in a year. (See Chart 11.) Meanwhile, Canada has recorded a services trade surplus for two months running, for the first time in decades. While border closures have brought non-essential travel to a halt, travel service exports have held up better than imports (see Chart 12) because they also include educational services to foreign students, many of whom remain in the country or continue to pay fees.
  • There is scope for auto and aircraft exports, which make up almost a quarter of non-energy goods exports, to rebound relatively quickly. The orderbook for the Airbus planes made in Canada was so large heading into the crisis that aircraft exports should rebound strongly even with travel restrictions in place, although virus-related operating constraints may prevent them from making up all the lost ground. Generous income support in the US, as well as signs that people are shunning public transit in favour of personal travel, leaves scope for a decent initial rebound in auto exports, although high unemployment will prevent them from completely rebounding for some time as well.
  • We are less optimistic about the potential for a strong rebound in energy export volumes. It seems likely that transportation demand for fuel will lag the overall global recovery, given continued restrictions and structural changes related to COVID-19. Compared to 2019, we expect oil demand across the Americas to be 10% lower in 2020 and still 5% lower in 2021. That implies energy export volumes will remain below pre-virus levels this year and next. (See Chart 13.) Similarly, this means we expect exports to lag the recovery in GDP growth in the US, at least until 2022. (See Chart 14.)
  • Signs of fresh US tariffs on imports of aluminum from Canada are not much cause for concern, as aluminum makes up just 2% of exports to the US. Any reduction in demand from the US should be offset by higher demand from China due to the latest fiscal stimulus there. And while US trade policy is hardly fixed these days, as the new trade agreement CUSMA is now in effect the US move seems unlikely to mark the start of serious trade tensions between the two nations.
  • Overall, we think the recovery in exports will lag that in imports (see Chart 15) because a greater share of imports are consumer goods, which due to household income support are likely to rebound quickly. We are assuming export growth of -8.2% this year, 3.0% in 2021 and 5.6% in 2022, against import growth of
    -6.4%, 5.8% and 3.2%. That means net exports will weigh on GDP growth in 2020 and 2021, before making a strong positive contribution in 2022 as exports finally get going again.
  • Our forecasts imply that the current account deficit will widen from 2% of GDP last year to almost 3% this year and 3.5% in 2021, before narrowing to nearer 2% by the end of 2022. (See Chart 16.)

External Demand Charts

Chart 9: Goods Exports & Imports Values ($bn)

Chart 10: Goods Trade Volumes (February to May, %)

Chart 11: Trade Balance ($bn)

Chart 12: Travel Services ($mn)

Chart 13: US Oil Demand & Oil Exports

Chart 14: US GDP & Canada Exports (%y/y)

Chart 15: Exports & Imports ($bn, 2015 Prices)

Chart 16: Current Account Balance (% of GDP)

 

Sources: Refinitiv, Bloomberg, Capital Economics


Domestic Demand

Consumption to recover faster than investment

  • The generosity of government income support has led us to revise up our forecast for consumption for the rest of 2020. We expect residential investment to rebound strongly, but non-residential investment is set to lag and the prospect of renewed COVID-19 outbreaks is a risk for the recovery more generally.
  • Employment remained 2.7 million below February’s level in May (see Chart 17), but the Canada Emergency Response Benefit (CERB) appears to have more than offset the loss of labour income. (See Chart 18.) That bodes well for the initial rebound in consumption now that restrictions on activity are being lifted. Indeed, following the 26% m/m fall in retail sales in April, Stats Can said their preliminary data point to an 18% rebound in May. Less encouragingly, restaurant visits appear to have plateaued lately, perhaps reflecting lower restaurant capacity limits. (See Chart 19.) Nevertheless, we now expect consumption to finish 2020 3% below its pre-virus level, compared to our previous forecast that it would be 5% lower.
  • The housing market remains a risk, but even our previous above-consensus forecast that house prices would fall by “just” 5% this year now looks too pessimistic. Admittedly, the stronger rise in new listings than sales in May could be a sign that some of the 15% of mortgage holders that have deferred their payments are desperate to sell. (See Chart 20.) But the local real estate board data for June looks more positive and the anecdotal evidence paints an encouraging picture of demand at the start of July as well. We are now assuming a broad stagnation of house prices across the country over the next two years, as economic weakness is offset by the boost to affordability from lower mortgage rates.
  • While the 48% plunge in construction investment from February to April looks worrying, it mainly reflected the enforced halting of investment in existing projects. The greater resilience of housing starts, which bounced back strongly in May (see Chart 21), leads us to think residential investment will rebound strongly. One unknown for both house prices and construction is immigration. Ahead of the virus, immigration was driving population growth by a record 1.3% y/y. (See Chart 22.) Immigration typically falls sharply after recessions, and even more so now given travel restrictions. Yet the government has reiterated its immigration targets and has pledged to make up for the lost ground once the restrictions are lifted. Moreover, moves in the US to limit immigration suggest there could be even more potential émigrés than before.
  • The CFIB Business Barometer has rebounded sharply but continues to point to deeply negative non-residential investment growth. (See Chart 23.) Business confidence seems likely to rise further, but we expect non-residential investment to lag residential investment and consumption for the next couple of years, as it will take some time for capacity utilisation to rise back toward pre-virus levels and spur investment again. Moreover, the still-low level of oil prices and reduced demand for fuel for travel purposes means that energy sector investment is likely to remain depressed at least this year and next. Prospects should brighten by 2022, when we expect oil prices to be back above $60 per barrel.
  • Overall, we expect domestic demand to slump by 5.2 % in 2020, before growing by 6.2% in 2021 and 2.8% in 2022. (See Chart 24.)

Domestic Demand Charts

Chart 17: Employment & Hours Worked

Chart 18: CERB Payments & Lost Income
(March to May, $bn)

Chart 19: OpenTable Restaurant Visits
(% y/y, 7-day average)

Chart 20: Home Sales & New Listings (000s)

Chart 21: Construction Investment & Housing Starts

Chart 22: Contribution of Immigration to Population Growth (%-points)

Chart 23: CFIB Business Barometer & Investment

Chart 24: Domestic Demand (% y/y)

 

Sources: Refinitiv, Bloomberg, Altus, Capital Economics


Inflation

Core inflation to bottom out near 1.5%

  • We expect an average of the Bank of Canada’s three core measures to bottom out at close to 1.5% this year. Subdued demand is likely to keep core inflation below 2% for the next few years, but a rebound in gasoline prices implies headline inflation should average near 2% in 2021 and 2022.
  • Headline inflation plunged from 2.4% in January to -0.4% in May, with 1.4%-points of that fall reflecting lower gasoline prices and a further 0.5%-points due to lower clothing prices. The contribution of shelter inflation to the headline rate fell by 0.4%-points due to a mix of lower mortgage cost and rental inflation as well as a reduction in electricity inflation, as the Ontario provincial government temporarily capped hydro prices. (See Chart 25.)
  • Gasoline prices have rebounded since April and, based on our forecast for WTI to rise from near $40 per barrel currently to $45 by the end of 2020 and $55 by the end of 2021, energy inflation is likely to rise much further. We estimate it will briefly hit 50% next April, from -14% in May, which would boost headline inflation by 3.2%-points. (See Chart 26.)
  • The three core inflation measures, CPI-trim, CPI-median and CPI-common, exclude volatile price movements. As the sharp drop in inflation since January has been concentrated in a handful of items, an average of the three was still at 1.7% in May. The traditional core measure, which excludes just energy and food, was 0.6%. (See Chart 27.)
  • While the economy is now re-opening again, there are a few factors that are set to weigh further on both headline and core inflation. Due to their big weights in the consumer basket, the declines in rental and mortgage interest costs inflation seem to have further to run. (See Chart 28.) We think reduced immigration and high unemployment will continue to put pressure on rents, with rental inflation dropping from 1.5% in May toward zero. As mortgage rates have fallen sharply, we estimate that mortgage cost inflation will fall from 3.3% in May to as low as -5.0% next year.
  • By contrast, the costs associated with operating in the COVID-19 environment, such as reduced capacity limits and new cleaning requirements, suggest inflation for many customer-facing services will rise. We expect the recent falls in inflation for items such as personal care services and food from restaurants to soon be reversed. The sharp declines in prices for some travel services are also likely to be reversed, although that will probably take longer to play out. (See Chart 29.)
  • Overall, the categories in which we expect to see higher inflation make up a similar proportion of the consumer price basket to those categories in which we expect lower inflation. (See Chart 30.) Accordingly, it seems unlikely that core inflation will fall much further. We expect it to bottom out at 1.5% in the coming few months. This view appears to be supported by firms’ pricing plans, which rebounded in May but remain relatively low. (See Chart 31.)
  • Given GDP is likely to remain below its pre-virus trend throughout our forecast horizon, we expect core inflation to rise back toward 2% only gradually. By contrast, the rebound in energy prices suggests headline inflation could briefly touch 3% next year. (See Chart 32.) Overall, we expect headline inflation to average 0.7% in 2019, 1.9% in 2021 and 1.9% in 2022, with the CPI-trim measure of core inflation averaging 1.6% in 2020, 1.5% in 2021 and finally 1.8% in 2022.

Inflation Charts

Chart 25: Contribution to Change in Headline Inflation from January to May (%-points)

Chart 26: WTI & Energy CPI (% y/y)

Chart 27: Core Inflation Measures

Chart 28: Mortgage Interest Costs & Rents Inflation (%)

Chart 29: Inflation (%)

Chart 30: Broad Moves by CPI Category
(% of consumer basket)

Chart 31: Firms’ Pricing Plans & Core Inflation (%)

Chart 32: Inflation (%)

 

Sources: Refinitiv, Bloomberg, Capital Economics


Monetary & Fiscal Policy

Asset purchases to continue in 2021

  • The magnitude of the coronavirus shock leads us to think the Bank of Canada will continue its asset purchases well into 2021 and that the government will run a deficit of 14% of GDP this calendar year. We expect the deficit to remain wide in 2021, at 7% of GDP, and do not anticipate any rate hikes in the next few years.
  • Under new Governor Tiff Macklem, the Bank has reiterated that the current policy rate of 0.25% is the effective lower bound. So the Bank is unlikely to reduce interest rates any further and is instead likely to focus on expanding its balance sheet. Its assets have risen from $120bn before the virus struck to over $500bn, equivalent to a rise from 5% of GDP to 12%. (See Chart 33.)
  • The pace of expansion has slowed since April as commercial banks reduced their use of repos and as the Bank’s holdings of Bankers’ Acceptances matured. The Bank continues to purchase around $12bn per week of government debt securities. (See Chart 34.) This reflects both the Bank’s Government Bond Purchase Program (GBPP) and the fact that the Bank is currently absorbing 40% of treasury bills at auction, up from the 25% that it normally buys. Since April, the Bank’s government debt purchases have exceeded the issuance of those securities. (See Chart 35.)
  • The Bank’s corporate and provincial bond purchase programs are also underway, but its corporate bond purchases so far amount to just $139mn over the first five weeks of the program, compared to $5.1bn of provincial bonds over the first eight weeks of that program. Both provincial and corporate bond spreads have narrowed sharply since the start of June. Unless they flare up again, we suspect the Bank will focus on keeping the GBPP running for as long as needed rather than expanding its purchases of other assets. We have assumed the GBPP will run well into 2021.
  • We also assume that the government will further extend some its emergency support measures, including the Canada Emergency Response Benefit for those that are unable to find work. This implies the federal deficit will hit 14% of GDP this year, and we expect it to remain wide at 7% in 2021. We are also factoring in a modest infrastructure spending plan, leading us to expect the deficit to remain relatively wide at 3% of GDP in 2022. (See Chart 36.)
  • Our view that it will take until at least 2023 before GDP returns to its pre-virus trend suggests there is little risk of inflation taking off, so we doubt the Bank will be in a rush to start raising interest rates once its asset purchases end. We agree with the path implied by Overnight Index Swaps (OIS) that the policy rate will still be 0.25% by the end of 2022. (See Chart 37.) The outlook beyond then could depend on whether the Bank changes its policy framework in the five-year review in 2021. If it adopted something like average inflation targeting, then it could end up keep interest rates at rock-bottom levels for years longer.
  • Our forecasts imply the net federal debt ratio will jump from below to 45% in 2022. (See Chart 38.) The overall general government gross debt-to-GDP ratio is set to rise to over 100%, but that would still compare favourably to many other economies (see Chart 39) and, given the Bank will continue to be a big buyer of the debt, we doubt it will put much pressure on borrowing costs. We expect the 10-year bond yield to rise only gradually, from 0.5% currently to 0.75% by the end of the year and 1% by the end of 2022. (See Chart 40.)

Monetary & Fiscal Policy Charts

Chart 33: Bank of Canada Assets ($bn)

Chart 34: Weekly Change in Assets ($bn)

Chart 35: Government Bond & Bill Issuance & Bank of Canada Purchases ($bn)

Chart 36: Federal Budget Balance (% of GDP)

Chart 37: Implied Policy Rate from OIS Curve (%)

Chart 38: Net Federal Government Debt (% of GDP)

Chart 39: Gross General Government Debt
(% of GDP)

Chart 40: Government 10-Year Yield (%)

 

Sources: Refinitiv, Bloomberg, Capital Economics


Long-term Outlook

High debt to hold back productivity growth in the 2020s

  • High private-sector debt is likely to hold back productivity growth in the coming decade relative to that in the US. And with the ageing population keeping a lid on labour force growth, we expect potential GDP growth to be just 1.5% from 2026-30, compared to 1.8% recently. From 2030, we expect potential growth to start rising again as productivity growth rebounds.
  • Canada has long stood out for having a relatively high total debt burden. At the end of 2019, total debt amounted to 294% of GDP, with household debt at 101% and non-financial corporate debt at 114%. (See Chart 41.) The coronavirus outbreak is likely to make the situation much worse for firms. While the government has offered various loan programs, the bulk of these must eventually be repaid.
  • High debt levels should not prevent a rebound in productivity in the first half of the 2020s as various sectors gradually return to capacity, but the high debt burden of the private sector is likely to act as a brake on investment and productivity growth beyond then. While we expect productivity growth in the US to pick up to 2% by the end of this decade, in Canada we expect it to be nearer 1.5%. Once corporates and households have reduced their debt loads, we expect productivity growth to start rising from 2030 onward and to eventually rise to over 2%, given there should be ample scope for Canada to catch up with the earlier gains elsewhere. (See Chart 42.)
  • The other side of potential GDP growth is labour force growth, which at the current juncture looks uncertain given the restrictions on immigration due to COVID-19. That said, the government has reiterated its immigration targets and recent moves by the US to reduce immigration makes Canada a more attractive destination. Accordingly, we see little reason to doubt the message from the UN population estimates that, at least once the virus has passed, net immigration will boost population substantially in the coming years. That should prevent the labour force from declining this decade despite a sharp rise in the share of those already living in the country above retirement age, and implies population growth will be stronger than in most places. (See Chart 41.)
  • Strong immigration should also help the government deal with the costs of the ageing population. Canada already has a strong start on this front given reforms to the pension system in the 1990s, but ageing populations also require greatly increased spending on healthcare. The budget deficit is likely to widen from an average of 1.5% per year before the virus hit to nearer 3% over 2030-50. So long as productivity growth picks up and immigration is strong, GDP growth should still be strong enough to bring the public debt burden back down following the coronavirus-related spike. (See Chart 44.)
  • Our forecasts for a pick-up in productivity growth in Canada and elsewhere imply that world interest rates will eventually start rising again, although the hit from the coronavirus means that is now likely to take longer than we previously anticipated. We have assumed the policy rate will remain below 1% for most of the rest of this decade, before rising toward 3.5% by the end of 2050s. That in turn will push the 10-year yield up from its current rate of near 0.5% to closer to 4.5%. Finally, we assume that the real price of oil will trend down from 2025 onwards. However, we do not expect this to put downward pressure on the exchange rate, given the likelihood that the relative importance of the oil sector will continue to fall as efforts to combat global warming lead to the adoption of new technologies.

Long-term Charts

Chart 41: Total Debt (% of GDP)

Chart 42: Productivity (% y/y)

Chart 43: Change in Population (%, 2020 to 2050)

Chart 44: Government Budget Balance & Gross Debt
(% of GDP)

 

Sources: Refinitiv, Capital Economics

Key Forecasts (% y/y, Averages, unless otherwise stated)

 

2006-2010

2011-2015

2016-2020

2021-2025

2026-2030

2031-2050

Real GDP

1.2

2.2

0.3

3.6

1.5

2.4

Real consumption

3.1

2.3

0.4

3.9

1.5

2.4

Productivity

0.1

1.0

-0.2

1.9

1.5

1.9

Employment

1.0

1.1

0.4

1.7

0.0

0.4

Unemployment rate (%, end of period)

8.0

6.9

9.4

5.7

5.5

5.0

Wages

2.9

3.1

5.0

2.1

3.4

3.7

Inflation (%)

1.7

1.7

1.6

2.0

2.0

2.0

Policy interest rate (%, end of period) (1)

1.0

0.5

0.3

0.5

1.0

3.5

Ten-year government bond yield (%, end of period) (2)

3.1

1.4

0.8

0.8

1.3

4.5

Government budget balance (% of GDP, average over period)

-1.0

-1.4

-2.9

-4.1

-2.0

-3.2

Gross government debt (% of GDP, average over period)

73

86

94

99

92

84

Current account (% of GDP, average over period)

-0.8

-3.0

-2.7

-2.7

-2.9

-3.5

Exchange rate (Canadian dollar per US dollar, end of period)

0.99

1.39

1.33

1.30

1.29

1.27

Nominal GDP ($bn, end of period)

1,677

1,433

1,621

2,190

2,440

6,325

Population (millions, end of period)

34

36

38

39

41

45

Sources: Refinitiv, UN, Capital Economics


Stephen Brown, Senior Canada Economist, stephen.brown@capitaleconomics.com

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