The Economic Forecast Council, 2005

Introduction

Every year, the Minister of Finance seeks the advice of the Economic Forecast Council (the Council) on the outlook for the provincial economy prior to the annual budget and presents the forecasts with the budget. This consultation process is a requirement of the Budget Transparency and Accountability Act.

The Minister met with the Council on December 3, 2004 to discuss their estimates for 2004 and the economic outlook for 2005 and beyond.

Council members discussed their views on the Canadian dollar as well as the international outlook. This was followed by a discussion of the province's near-term economic outlook, as well as factors affecting the province's medium-term outlook.

The Economic Forecast Council requested the opportunity to update their survey in January due to the availability of new information. Consequently, the Council was re-surveyed on January 10, 2005. The underlying forecast details from these January surveys are summarized in the table at the end of the topic box.

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Overview

Following estimated growth in the British Columbia economy of 3.5 per cent in 2004, the average of participants' forecasts called for growth of 3.3 per cent in 2005, 3.1 per cent in 2006 and 3.0 per cent for the 2007 to 2009 period. Council members saw BC as well positioned to post strong growth over the next couple of years relative to the other Canadian provinces. British Columbia was expected to outperform Canada in 2005 by almost all of the council members. In the medium-term, council members expected infrastructure related to the 2010 Olympics, a strong domestic economy supported by higher migration, increased consumer and business confidence, growing trade with Asia and improved fiscal flexibility of the provincial government to result in robust growth.

The outlook for the Canadian dollar and the impact of the dollar's appreciation on the Canadian and BC economies was one of the main concerns of Council members, and was their main forecast risk.

International Outlook

Following expected growth of 4.4 per cent in 2004, the participants' average forecast points to U.S. growth of 3.4 per cent in 2005 and 3.3 per cent in 2006, before slowing to 3.1 per cent for the 2007 to 2009 period.

Several council members expressed concern surrounding the twin deficit problem in the U.S. and its potential impact on growth. However, some council members felt the impact was limited to the next couple of years while others saw the twin deficit problem as more of a medium-term issue.

The Council felt that growth in Europe and Japan would be slower than that of the U.S. economy over the forecast period, partly due to weakening net exports from stronger domestic currencies.

The Canadian Economy

The Canadian economy benefited from strong commodity prices in 2004. Several council members saw slower U.S. growth and the higher Canadian dollar combined with softer commodity prices translating into a weaker trade sector performance in 2005, pushing Canadian economic growth below potential.

For 2005, Canadian growth was forecast to be 2.8 per cent on average, climbing to an average forecast of 3.0 per cent in 2006 before moderating slightly to 2.9 per cent on average for 2007 through 2009.

The rapid appreciation of the Canadian dollar was seen to be the biggest concern in terms of Canadian economic growth. Although many council members pointed out that high commodity prices and lower Canadian interest rates could partially offset the impact of the Canadian dollar.

Financial Markets

Most Council members saw an increase in the intended Federal Funds rate in 2005, as higher inflation in the U.S. would require the Federal Reserve to raise interest rates in order to re-establish positive real interest rates. Higher interest rates were expected to dampen the U.S. housing market, which could negatively impact BC's forestry exports.

The intended federal funds rate¹ was projected to be 2.77 per cent on average in 2005, rising to 3.55 per cent in 2006 on average. Over the 2007 to 2009 period the intended federal funds rate forecasts averaged 4.15 per cent.

In Canada, the Council generally felt that the Bank of Canada would remain on the sidelines for much of 2005, with the overnight target rate² expected to average 2.79 per cent for the year. The interest rate spread between the U.S. and Canada was expected to narrow on average over the medium-term. The Bank of Canada's overnight target rate was forecast to average 3.31 per cent in 2006 and 3.86 per cent over the 2007 to 2009 period.

The Council's average forecast for the exchange rate was 82.6 cents US in 2005, up from 77.2 cents US in 2004. Forecasts ranged from a low of 78.0 cents up to a high of 90.5 cents. In 2006, the average of participants' exchange rate forecasts was 82.1 cents US with the majority expecting a steady or depreciating Canadian dollar. On average, the Council expects the Canadian dollar to hold steady over the medium-term to average 82.2 cents US for 2007 to 2009. Council members continued to have divergent views on the level of the Canadian dollar over the medium-term, although the range of participants' opinions narrowed somewhat. Over the 2007 to 2009 period, the range of Council members forecasts of the Canadian dollar was from 78.0 cents US up to 88.2 cents US.

The higher Canadian dollar was seen as the largest risk to the outlook; the Council discussed both the upside and the downside to a stronger currency. Potentially negative impacts of the higher Canadian dollar would be lower exports and tourism activity. Potential benefits of the stronger dollar mentioned by Council members included, less aggressive tightening by the Bank of Canada, which would help sustain Canadian housing markets, as well as increased investment in productivity enhancing machinery and equipment from the U.S.

1	The federal funds rate is the interest rate at which depository institutions lend balances at the Federal Reserve to other depository institutions overnight.
2	The overnight target rate is the midpoint of the Bank of Canada’s operating band for overnight financing.

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British Columbia Forecast

On average, participants expected BC's economy to post growth of 3.3 per cent in 2005, 3.1 per cent in 2006 and 3.0 per cent during the 2007 to 2009 period. Forecasts for BC economic growth in 2005 ranged from 2.8 per cent up to 3.8 per cent. Almost all of the Council members are expecting BC to outperform Canada in 2005. Participants cited BC's diversified export markets, increased consumer and business confidence, the province's ties to Asia, the provincial government's enhanced fiscal flexibility, infrastructure projects and the dampened impact of the high Canadian dollar on BC relative to other provincial economies as reasons for BC's strong performance.

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As shown in Charts 4 and 5, Council members views were relatively convergent on their BC growth forecasts for 2005 and 2006.

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However, for the longer term forecast for the 2007-09 period, there was a wider spread. While a large group (six members) expected growth of 3.2 per cent or higher, the average forecast was reduced by a group (four members) predicting growth of 2.7 per cent or less (see Chart 6).

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External Issues

The Council discussed the sustainability of the U.S. recovery and the economy's vulnerability due to high consumer debt loads and the twin deficits. While BC's economy has a diversified export market, the U.S. is still the province's major trading partner and a downturn in the U.S. economy would have a negative impact on BC.

In addition, participants noted that BC is well positioned to benefit from increased trade with Asia, especially China. In particular, infrastructure improvements including ports, railways and border-crossings will help BC make the most of the province's geographical proximity to rapidly expanding Asian markets.

The potential resolution of the softwood lumber dispute with the U.S. was also mentioned by the Council as a positive factor for the BC outlook. However, all of Council members expect the U.S. housing market to slow in 2005 and 2006.

Sectoral Issues

In terms of the domestic economy, the Council discussed the areas of housing, immigration and energy sector development.

Since the Council on average expects Canadian interest rates to remain fairly low next year, the housing sector in BC was expected to be robust in 2005. Housing starts in BC will also be driven by increased migration as BC performs well relative to other Canadian provinces. The Council on average saw housing starts easing somewhat from the high levels seen in 2004 but remaining robust with an average of 30,559 units in 2005. There was a wide range of forecasts of housing starts in 2005, from 25,000 units up to 34,500 units.

Development of oil and gas in BC and the industry's increasing contribution to the BC economy were mentioned by several Council members. High energy prices have been supporting oil and gas exploration and investment in machinery and equipment has been less costly due to the higher Canadian dollar.

Government

The improved fiscal position of government was also noted as a positive factor by Council members. By balancing the provincial budget, government has more fiscal flexibility. In addition, the government has more flexibility to maintain a competitive tax regime and invest in infrastructure.

Most of the Council members mention the 2010 Olympics as an important medium-term issue for the BC economy. Rising construction costs were an area of concern including possible labour shortages. Increased capital spending and tourism leading up to the Olympics were expected to provide a lift to the BC economy over the medium-term.

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