Economic growth in the United States, which had been weak over the first half of the year, appears to have picked up. Real gross domestic product (GDP) rose 2.9% at annual rates in the July to September 2016 period according to the advance estimate. This follows three quarters in which economic activity expanded by just 1% on average. Growth in the most recent period was wide-spread across major categories, although residential investment contracted for a second straight quarter. Higher frequency indicators, such as hiring and wage growth continue to point to a healthy economy. The post-election stabilization in financial markets and rising measures of inflation compensation should provide further support for the Federal Reserve to raise its policy interest rate by 25 bps on December 14, 2016.
Looking forward, U.S. consumer spending is expected to continue
to outpace overall economic growth in coming quarters, supported by a healthy labour market. Residential construction is forecast to return to positive growth, helping drive economic activity. Healthy demand and a lack of inventory, as well as an improvement in recent data all suggest that the recent pull-back in the sector has come to an end. The U.S. 2016 election results have shifted market expectations towards larger budget deficits, higher inflation, and increased monetary tightening by the Federal Reserve. Bond yields have risen markedly as a result, as has the U.S. dollar. However, there remains a high degree of uncertainty at present regarding the size and composition of any potential fiscal stimulus. As a result, there is some downside risk to the U.S. economy resulting from the twin headwinds of higher bond yields and a stronger dollar, absent a fiscal offset.
The key economic theme in Canada remains the complex adjustment process resulting from the marked declines in commodity prices since 2014. The wildfires in Fort McMurray exerted an additional drag, although the effect appears to have already largely dissipated. Business investment is thought to have finished contracting, but meaningful growth is not expected until early 2018, as oil prices remain unsupportive of further investment and manufacturing sales growth remains weak. As the economic adjustment process continues, external demand
for Canadian goods and services should provide some relief. Following a disappointing performance in early 2016, export volumes have recovered somewhat. Continued U.S. growth should provide support to Canadian exports going forward.
The real estate sector has been a key driver of economic growth
in Canada, supported by a low interest rate environment and gains in home prices. Growth is expected to remain strong in 2016, but momentum is projected to ease significantly as the impact of past interest rate decreases fade and a number of recently-implemented tax and regulatory changes act to ease demand. While a correction is expected, it will likely be modest in scope in light of continued low interest rates and a stable unemployment rate.
Government spending is also expected to provide a boost to growth over the second half of calendar 2016 and throughout 2017. Although the impact of the Canada Child Benefit on consumer spending appears modest, significant infrastructure spending is poised to lift Canada’s real GDP growth rate in 2017 by as much as 0.3 percentage points. Newly-announced measures by the federal government in its recent Fall Update, including a “Canada Infrastructure Bank” as well as a new global skills strategy could provide some additional economic stimulus over the medium-to-longer term.
Against the backdrop of modest economic growth and a labour market that is expected to generate only modest employment gains, inflationary pressures are likely to remain in line with the Bank of Canada’s renewed target of 2%. Although overall inflation is currently below this target, the impacts of past energy price declines are fading, while import prices are rising. As a result, we expect inflation to converge back towards the central bank’s target by the middle of the 2017 calendar year.
Given the muted inflationary pressures, the Bank of Canada
is expected to maintain its policy rate at 0.50% through the end of 2018. This is consistent with the Bank of Canada’s most recent forecast, which showed that a degree of economic slack would persist until the middle of the 2018 calendar year. There are a number of important risks that may push the Canadian economy off course. Should U.S. demand disappoint, Canadian export growth is likely to follow suit, removing an important source of growth. While focused on Mexico and China, protectionist sentiment may impact Canadian exports, and by extension business investment. A renegotiated North American Free Trade Agreement may also see a reduction of trade access, permanently slowing economic growth. A string of upcoming elections in the euro area may result in increased global uncertainty and volatility. Domestically, high household debt levels may precipitate a consumer deleveraging cycle. With the consumer accounting for more than half of economic activity, a sharp slowdown in personal consumption growth will have a deleterious effect on the economy as a whole. Similarly, a moderation in housing activity, whether driven by weakened affordability or a stronger than expected impact of recent regulatory changes, would remove what has been a key driver of growth in recent quarters.
26 TD BANK GROUP ANNUAL REPORT 2016 MANAGEMENT’S DISCUSSION AND ANALYSIS
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