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Part 3: BRITISH COLUMBIA ECONOMIC REVIEW
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| 1 | Reflects information available as of February 7, 2005. All annual and quarterly references are for the calendar year. |
The performance of key BC economic indicators in recent quarters is presented in Table 3.1.
Both employment and retail sales showed positive growth in the October to December quarter of 2004. For the year, employment recovered strongly from negative growth in the January to March quarter to record annual growth of 2.3 per cent for 2004. The unemployment rate has been below 7.0 per cent for the past five months, and was 6.5 per cent in January 2005. Retail sales growth was robust, increasing 6.4 per cent on a year-to-date basis to November.
Housing starts saw growth in excess of 20 per cent for the third straight year in BC, rising 25.8 per cent in 2004. Both manufacturing shipments and exports weakened in the final quarter of 2004, as the high Canadian dollar started to dampen the value of shipments. Due to strong gains at the beginning of the year, manufacturing shipments were up 12.7 per cent year-to-date to November. The value of merchandise exports peaked in May 2004 and fell throughout the rest of the year. The strength in exports earlier in the year resulted in an increase of 10.6 per cent during the first eleven months of 2004, relative to the same period in 2003. Non-residential building permits increased 12.4 per cent in 2004, primarily due to growth in commercial and industrial construction. While these indicators show a strong performance for the BC economy overall in 2004, several key economic indicators slowed in the final three months of 2004.
The U.S. economic recovery picked up steam in 2004, posting annualized growth of 4.0 per cent in the third quarter and 3.1 per cent in the fourth quarter. Real consumer spending was an important driver of growth, rising 4.6 per cent on an annualized basis in the final quarter of 2004. Business investment was also up substantially in the fourth quarter due to strong capital equipment spending. Real exports declined in the October to December period of 2004 and the trade deficit was the biggest drag on fourth quarter U.S. GDP.
Overall, the U.S. economy grew by 4.4 per cent in 2004, up substantially from 3.0 per cent in 2003. At the end of 2004, falling oil prices and gains in employment supported improved consumer confidence. Retail sales in the U.S. rose 7.6 per cent in 2004. While the U.S. labour market showed some signs of strength in 2004, it was not able to generate the steady pace of growth consistent with an expanding economy. The construction industry was one of the labour market highlights, increasing by 265,000 jobs or 3.4 per cent during the year. Residential construction in the U.S. increased 5.1 per cent in 2004, reaching 1.9 million units. However, analysts expect employment in construction to decline in 2005 as the U.S. housing market slows.
After the 4.4 per cent growth seen in 2004, the January Consensus Economics survey expects U.S. real GDP growth of 3.6 per cent in 2005 and 3.4 per cent in 2006. The consensus outlook for 2005 has been improving for the U.S. over the past two months. The pace of growth in the U.S. for 2005 is expected to ease from the strength of 2004 but remain robust, as the weaker U.S. dollar boosts exports and the manufacturing sector picks up.
The Ministry of Finance assumes U.S. economic growth of 3.2 per cent in 2005, somewhat below the current 3.6 per cent consensus. In 2006, U.S. growth is expected to moderate to 3.0 per cent in the Ministry of Finance forecast, while the January consensus survey predicts more robust growth of 3.4 per cent for the year. Over the medium-term, the Ministry of Finance assumes that the U.S. economy will grow at a rate of about 3.0 per cent per year. The Ministry of Finance's growth assumptions are somewhat lower than the consensus, reflecting the risk surrounding the sustainability of the U.S. economic recovery and the twin fiscal and current account deficits.
The rapid appreciation of the Canadian dollar relative to the U.S. dollar dampened Canadian economic growth in 2003; real GDP growth was 2.0 per cent. In 2004, the Canadian dollar was once again a factor for the Canadian economy and growth is expected to soften in the final quarter. Weakness in the manufacturing and export sectors is anticipated for the final three months of 2004.
Employment in Canada continued to be robust in 2004 with the construction industry posting strong job gains. The manufacturing sector continued to perform poorly, especially in the second half of the year when the Canadian dollar appreciated quickly. Overall, the Canadian economy added 284,600 jobs in 2004, an increase of 1.8 per cent. Low interest rates continued to drive up the housing market in 2004 and Canadian housing starts totalled 233,431 units for the year. Canadian retail sales increased 4.5 per cent over the first eleven months of 2004, compared to the same period in 2003. Much of the strength was seen in furniture and home improvement stores while auto sales continued to dampen growth. Retail sales excluding autos and parts were up 6.1 per cent during the first eleven months of 2004 relative to the same period the previous year.
The Consensus Economics survey downgraded Canadian growth expectations for 2005 in their past three monthly surveys. Forecasters lowered their growth forecasts on average to reflect lower exports resulting from the appreciation in the Canadian dollar, as well as weakness in the manufacturing sector. The January survey calls for growth of 2.8 per cent for 2005 and 3.0 per cent for 2006. The Ministry of Finance forecast is slightly more conservative than the consensus, and assumes that the Canadian economy will underperform the U.S. economy over the next two years, with growth of 2.7 per cent in both 2005 and 2006.
The Japanese economy started 2004 with strong growth but economic conditions have deteriorated over the course of the year. January's Consensus Economics survey predicts economic growth in Japan will slow from an estimated 2.9 per cent in 2004 to 1.1 per cent for 2005 and 1.9 per cent in 2006. The Ministry of Finance is assuming slightly lower growth of 0.8 per cent in 2005, rising to 1.5 per cent in 2006.
In 2004, China's GDP growth was 9.5 per cent with robust exports and agricultural production. China attempted to restrain growth by raising interest rates and putting in place economic controls to cool investment over the past year. While growth is expected to slow somewhat in 2005, further interest rate hikes or some adjustment of the currency may be needed.
Germany's economy continues to struggle as the long-awaited turnaround in consumer spending has failed to materialize and employment continues to stagnate. The poor performance of Europe's largest economy will impact the overall growth prospects for Europe in the near-term. The Ministry of Finance forecasts growth of 1.5 per cent in 2005 and 1.8 per cent in 2006 for Europe.
The U.S. federal funds rate was held at 1.00 per cent for the first half of 2004. Starting at the end of June, the Federal Reserve Board raised this key target interest rate by 25 basis points at each of their next five meetings, up to 2.25 per cent by the end of 2004. The Bank of Canada ended their easing cycle in April of 2004 by lowering the target overnight rate to 2.00 per cent. The Bank of Canada sat on the sidelines through the summer, and only started raising interest rates in the fall with 25 basis point increases at both their September and October meetings. The target for the overnight rate in Canada ended 2004 at 2.50 per cent.
At their February 2nd meeting the Federal Reserve Board raised its key target interest rate by 25 basis points to 2.50 per cent. There was no change in their risk assessment, stated as "roughly equal" by the committee in terms of upside and downside risks for both sustainable growth and price stability. This latest move by the Federal Reserve eliminates the gap between the target interest rates for Canada and the U.S., as they are both 2.50 per cent.
Outlook
Consistent with private sector forecasts, the Ministry of Finance assumes that the U.S. federal funds rate will rise at a measured pace, to remove monetary stimulus from the economy. Despite high energy prices and a lower U.S. dollar, the rise in interest rates should keep inflationary pressures in check.
Canadian growth expectations are weaker than for the U.S. and most analysts predict that the Bank of Canada will stay on the sidelines for the near-term. This would result in the short-term interest rate spread between Canada and the U.S. becoming negative early in 2005. Canadian interest rates are also forecast to rise, although later and perhaps more slowly than in the U.S.
The Canadian three-month treasury bill rate is expected to average 2.7 per cent in 2005, rising to 3.4 per cent in 2006. Ten-year government bonds are forecast to average 4.7 per cent this year and 5.0 per cent in 2006. The Ministry of Finance outlook was based on the average of six private sector forecasts as of January 5, 2005.
The Canadian dollar averaged 76.8 cents US in 2004, up from 71.4 cents in 2003 and ended the year strongly, averaging 82.0 cents US in December. The recent appreciation in the Canadian dollar was due in part to U.S. dollar weakness, resulting from concerns surrounding the ability of the U.S. to finance its large current account and budget deficits.
Outlook
The weakness in the U.S. dollar is generally expected to continue, however, there are other factors that may constrain the Canadian dollar's appreciation. Overall, non-energy commodity prices are expected to decline in 2005, and the Canadian dollar has generally tracked commodity prices quite closely over the past decade. The interest rate spread between Canada and the U.S. is also likely to become less supportive of the Canadian dollar, as spreads are forecast to move into negative territory.
The private sector forecast of the Canadian dollar in 2005 averages 84.4 cents US, falling to 83.0 cents US in 2006. The Ministry of Finance exchange rate outlook is based on these private sector averages (see Table 3.4). As the interest rate spread between Canada and the U.S. is anticipated to remain small in the medium-term, the Canadian dollar is expected to continue at around 83.0 cents US for the 2007 to 2009 period.
After strong growth in 2004, the Ministry of Finance expects economic growth in British Columbia to outperform Canadian growth in 2005 at 3.1 per cent. Over the medium-term, economic growth in BC of 3.0 per cent is expected, reflecting robust exports, investment and productivity growth. This outlook is consistent with, but slightly lower than the Economic Forecast Council (see Table 3.5).
Table 3.6 summarizes the Ministry of Finance's outlook for key economic indicators, while Tables 3.8.1 to 3.8.5 at the end of Part Three provide additional detail on the economic forecast.
Employment growth in British Columbia was robust in 2004 averaging 2,059,700 persons employed, an increase of 2.3 per cent from 2003. The 45,500 jobs created in 2004 represent an increase in full-time employment of 63,500 jobs offset by a decline in part-time employment of 18,000 jobs. Job growth in British Columbia was broadly based, with both goods and services sectors expanding in 2004. The unemployment rate in British Columbia averaged 7.2 per cent in 2004, down from 8.0 per cent in 2003 as growth in employment outweighed growth in the labour force.
Outlook
Employment is forecast to increase by 1.9 per cent in both 2005 and 2006, adding about 40,000 jobs in each year. The labour force is expected to grow at about the same pace as employment for 2005 and 2006, resulting in a steady unemployment rate of 7.2 per cent for these two years. Over the medium-term, the unemployment rate is forecast to decline gradually.
Consumer Spending and Housing
Retail sales picked up in 2004 with the increase largely being driven by the strong housing market as much of the strength was seen in furniture, home electronics and appliances as well as home improvement stores. The value of total retail sales rose 6.4 per cent in the first eleven months of 2004 relative to the same period of 2003. In addition to furniture and home-related purchases, the value of fuel sales increased substantially over the first eleven months of 2004, reflecting higher market prices for gasoline.
Housing starts posted another strong performance in 2004 with continued low mortgage rates and robust employment gains supporting growth in demand. British Columbia housing starts totaled 32,925 units in 2004, a 25.8 per cent increase over the previous year.
Outlook
Consumer spending on goods and services adjusted for inflation is forecast to increase 3.3 per cent in 2005. Steady growth in employment and personal income will support consumer demand for goods and services this year. In 2006, further growth of 3.2 per cent is expected in real consumer spending, followed by growth of 2.9 per cent on average over the medium-term. Retail sales are forecast to rise 5.2 per cent in 2005, followed by growth of 4.9 per cent in 2006.
Housing starts in British Columbia are expected to ease off gradually over the forecast period as interest rates rise and demand becomes satiated. Housing starts are forecast to total about 32,000 units in 2005, falling to 31,700 units in 2006. Over the medium-term housing starts are forecast to decline gradually reaching 30,700 units by 2009.
The value of BC's merchandise exports rose 10.6 per cent in the first eleven months of 2004, relative to the same period of 2003. The effects of a higher Canadian dollar on forestry exports were offset by high lumber prices, resulting in an increase of 16.5 per cent in forestry exports year-to-date to November. Lumber prices were up 46.0 per cent on average for 2004 compared to the previous year. The spruce-pine-fir price hit a high of US$465 in the first week of May but was back down to US$361 by the end of the year. However, energy exports fell 5.1 per cent during the first eleven months of 2004 compared to the same period the previous year, as gas volumes declined and the value of electricity exports fell. The value of merchandise exports excluding forestry increased 6.2 per cent year-to-date to November, reflecting strength in other export commodities such as industrial goods.
Canadian natural gas prices continued to be volatile over the course of 2004, with the highest price of $6.1C/GJ occurring in June followed by a low of $4.7C/GJ in September. However, on average for 2004 the natural gas price increased a relatively moderate 1.7 per cent. Natural gas prices generally follow oil prices, however in 2004 favourable weather conditions kept storage levels high, dampening this effect significantly. Without this mitigating factor, most analysts agree that natural gas prices could have been much higher in 2004.
Coal prices were strong in 2004, driven largely by China's rapid economic growth and import demand. Increased demand for steel in turn raised demand for coal, supporting higher coal prices.
Overall, the average price of British Columbia goods and services exports grew an estimated 4.2 per cent in 2004 helping to offset the impact of a higher Canadian dollar on BC exporters.
Outlook
Real exports of goods and services are expected to increase 2.4 per cent in 2005. This is somewhat lower growth than the 3.5 per cent seen in 2004, reflecting the higher Canadian dollar combined with a decline in export prices and easing of Japanese demand. Real export growth is forecast to increase after 2005, consistent with economic growth in BC's trading partners and improving export prices.
The average price of British Columbia goods and services exports is forecast to decline 2.1 per cent in 2005, as key commodity prices, such as lumber, ease off from high levels and the stronger Canadian dollar reduces the value of exporters sales. Natural gas prices are forecast to level off at C$4.65/GJ in the medium-term. Spruce-pine-fir prices are expected to average US$319 per thousand board feet in 2005 and US$300 through the remainder of the forecast period. The average export price is expected to pick up moderately over the medium-term as commodity prices stabilize and the Canadian dollar remains around 83.0 cents US.
Business investment (including residential) adjusted for inflation is estimated to have expanded 8.1 per cent in 2004, building on robust growth in 2003 of 7.4 per cent. While much of the growth in business investment was driven by strong residential investment, which is estimated to have increased 10.8 per cent in 2004, investment in both machinery and equipment as well as non-residential investment also saw robust growth. Business confidence in BC remained strong in 2004, remaining above Canada as a whole.
Machinery and equipment investment benefited from the higher Canadian dollar, rising an estimated 5.4 per cent in 2004, as costs were lower for industries importing equipment from the U.S. Non-residential construction saw an estimated increase of 6.8 per cent last year. Corporate profits in British Columbia grew 11.2 per cent in 2003, and are estimated to have another strong year in 2004 with growth of 19.9 per cent expected.
Local, provincial and federal government combined spending is estimated to have increased 2.3 per cent in 2004 in inflation-adjusted terms.
Outlook
Total investment in British Columbia is forecast to grow 5.5 per cent in 2005 and 5.1 per cent in 2006. This growth reflects the machinery and equipment and non-residential investment sectors gaining strength to offset the easing of residential investment, as well as public sector investment in capital projects. Over the medium-term, total investment in British Columbia is expected to average growth of 4.9 per cent.
Combined spending by the three levels of government in inflation-adjusted terms is expected to grow 3.1 per cent in 2005 and increase 0.8 per cent in 2006. Over the medium-term, inflation-adjusted government spending is forecast to rise 1.9 per cent on average per year.
Consumer price inflation in both BC and Canada began 2004 quite low, but high fuel prices drove up inflation over the summer months and into the winter before falling in December. In Canada, overall consumer price inflation averaged 1.9 per cent in 2004, a significant decrease from the 2.8 per cent rate of inflation seen in 2003. The slowdown in the average annual rate of inflation in 2004 was due mainly to a much smaller increase in automotive vehicle insurance premiums during the year, as well as a decline in natural gas and computer equipment and supplies prices. British Columbia experienced similar consumer price inflation to Canada as a whole in 2004; inflation averaged 2.0 per cent for the year.
Outlook
Consumer price inflation in British Columbia and Canada is expected to continue to average 2.0 per cent per year over the forecast period, in line with the Bank of Canada's inflation target.
The economic outlook has risks on both the upside and downside. The most significant risks to the British Columbia outlook remain the volatility of the Canadian dollar and sustainability of the U.S. economic recovery.
The British Columbia economy could grow faster than forecast if:
Alternatively, the British Columbia economy could grow slower than forecast if:
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