Wednesday Night #1175 Jacques Clément Report on the Economy

8 September 2004
Canada
As expected sometime ago, the Bank of Canada today (Wednesday) raised its administrated rates by a ¼ to 2.25% overnight rate and 2.5% discount rate given “strong external demand, pushing the economy close to its capacity limit”, with total inflation close to 2.5%, and core at 1.9% (close to its target). With the first increase in 1½ years, the Bank wants to reduce the degree of monetary stimulation that was injected into the economy after the U.S. recession to prevent inflationary pressures from developing.
Very strong second quarter GDP growth of 4.3%, after a revised 3% in the previous quarter, was the result of a seven-year high in the trade surplus, reaching a record $8.6 billion in June, rising business investments and strong consumer spending. Manufacturing shipments and new orders reached record levels in June. Inventory rebuilding continues at a moderate pace. Wholesale sales rose by over 5% in the second quarter,- the largest gain in 10 years. Leading economic indicators are the strongest in two years. June employment was stronger than expected. Business and consumer confidence remained strong, as did corporate profits. Residential construction reached record levels in Q2. Business and government spending (Ivey Index) rose for the 13th consecutive month, as did prices and employment. Building permits eased 11% in July after rising 29% in the previous month. The residential sector is up 18%. Average price of home ownership has come off very slightly to about $241,000. It will likely slow very moderately next year, as central banks tighten policy and mortgage rates will start to rise. New vehicle sales were off almost 2% in June, its second consecutive monthly decline. Q2 balance of payments surplus at $10.4 billion was very close to a record.
With those strong fundamentals, the Canadian dollar will rise heading for 77 – 79 cents US, some are talking 80 cents.
Expectations that China may soon become the principal trading partner of the U.S. could be a concern. Sixty percent of U.S. imports from China are from U.S. companies based there. But Chnese companies are also expanding exports rapidly – Nortel’s CEO is already talking about competition coming from China.

China is overtaking Canada as the largest trading partner of the U.S.
I don’t think we’re half as smart as the Chinese and whatever they do will be to their benefit, not to ours – we should never forget that in their eyes, we (Occidentals) are barbarians

The economy is closing in very quickly on full capacity with consequences for the rate of inflation. While inflation is now at 2.3%, the Bank of Canada thinks that average core inflation will reach 2% at the end of the year – not alarming but it is rising.
The central bank had to start picking out excess monetary stimulus, therefore in October, we will see tightening by another ¼, otherwise inflation pressure will develop.
With such positive fundamentals and the likelihood of another ¼ rise in interest rates on October 19th, the Canadian dollar should continue to trade between 77 cents US and 78 cents in the near term.

U. S.
The situation in the U.S. is completely opposite to Canada, although the U.S. economy is also close to capacity.
After 4.5% real growth in the first quarter, GDP in the second quarter was a disappointing 2.8%, its weakest pace of growth since Q1 2003, confirming the “soft patch” assessment by Alan Greenspan in June. This was led by a high trade deficit (a record $56 billion in June), slowdown in consumer spending, weak employment,- except for August when 144,000 jobs created-, declining economic indicators, declining consumer confidence, a weak manufacturing sector, and flat construction spending, all related to a substantial rise in energy prices. However, Greenspan expects that “the economy is poised to resume a stronger pace of expansion given the record low level of interest rates and the robust underlying growth in productivity, providing support for the economy.” Led by strong new vehicle sales in July, retail sales that rebounded strongly and consumer spending that is expected to rise by over 4% in Q3. Housing starts also recovered strongly in July despite a decline of 3% in existing home sales, the first drop in seven months (but after a record month in June).
Consumer sentiment picked up in July-August (both Michigan and Conference Board), personal income continues to rise, although at a more moderate pace, and personal consumption rebounded sharply in July. Corporate profits rose by 25% (annual rate) for the third consecutive quarter. Factory orders were very strong in July and construction spending is recovering. August economic data was mixed with the 12th consecutive monthly increase in employment – the largest since May-, but a weaker I.S.M. manufacturing index and weaker services. Leading economic indicators declined in the last two months. Inflation is at 3%, but the core a moderate 1.4%. The Fed is likely to tighten again on 21st September to 1.75%. The second half GDP is expected to rise to between 3.5% and 4%.

Near term outlook:
· Crude $42 to $44;
· Gold $400 – $410;
· Euro $1.21 – $1.23 US.

Wednesday Night agreed that the Canadian economy was “rock solid” and we look forward to a sustained period of strong growth.