The Economic Forecast Council, 2005

Introduction

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

Prior to the February 15, 2005 budget, the Minister had met with the Council on December 3, 2004 to discuss their estimates for 2004 and the economic outlook for 2005 and beyond.

The Economic Forecast Council has been re-surveyed on July 28, 2005 for the September Budget Update. The underlying forecast details from these surveys are summarized in the table at the end of the topic box.

Overview

Following growth in the British Columbia economy of 3.9 per cent in 2004, the average of the Council's forecasts now call for growth of 3.6 per cent in 2005, 3.4 per cent in 2006 and 3.3 per cent for the 2007 to 2009 period. All Council members expected growth in the BC economy to outpace that of Canada for 2005. For BC, the solid domestic outlook was expected to be partially offset by the drag of net exports on growth this year, while the outlook for job creation remained robust. In the medium-term, Council members noted that non-residential construction related to the 2010 Olympics and a strong domestic economy supported by higher migration would sustain strong growth rates in that sector. In addition, growing trade with Asia and improved (provincial government) fiscal flexibility was expected to result in overall robust growth over the medium-term.

Forecast risks identified by the Council included labour shortages and resulting upward pressures on prices related to infrastructure projects for the 2010 Olympics, the strength of the Canadian dollar, slowing North American housing markets, and the potential for weakening global economic growth.

International Outlook

On average, the Economic Forecast Council expected growth of 3.6 per cent in the U.S. economy for 2005. The Council's average forecast was for U.S. growth of 3.2 per cent in 2006 and 3.1 per cent for the 2007 to 2009 period.

Several Council members cited a slowdown in U.S. growth as a risk to the outlook, particularly in terms of a slowing housing sector. The housing sector's contribution to growth was expected to moderate as higher interest rates and high levels of consumer indebtedness dampen housing activity. Slowing of the North American housing sector would have a negative impact on BC's exports of forest products.

The Council mentioned that growth in China was expected to moderate; contributing, along with the U.S., to an overall cooling of world GDP growth. The strength of the Japanese economic recovery remained an issue of concern for the Council. While growth in Japan currently appears more sustainable, decelerating growth in China could derail Japan's economic growth expectations.

The Canadian Economy

The Canadian economy is still working through the impacts of the rapid appreciation of the Canadian dollar seen in 2003 and 2004. Council members noted that the higher Canadian dollar and weaker external demand, combined with softening commodity prices, could result in Canadian economic growth below potential.

For 2005, Canadian growth was forecast to be 2.7 per cent on average, climbing to an average forecast of 2.9 per cent in 2006 and 2007 through 2009.

The risks to the Canadian outlook cited by Council members included a renewed appreciation of the Canadian dollar, slowing global demand and a more rapid downturn in commodity prices.

Financial Markets

Most Council members expected the Federal Reserve to slow the pace of tightening at the end of this year and into 2006, due to the sensitivity of the U.S. economy to higher interest rates. The higher federal funds rate¹ was expected to dampen the U.S. housing market, which could negatively impact BC's forestry exports.

The intended federal funds rate was projected to be 3.2 per cent on average in 2005, rising to 3.9 per cent in 2006 on average. Over the 2007 to 2009 period forecasts of the intended federal funds rate averaged 4.2 per cent.

In Canada, the Council generally felt that, with contained inflation and modest growth expectations, the Bank of Canada would remain on the sidelines or tighten modestly through the end of 2005. The overnight target rate² was expected to average 2.6 per cent for 2005. For the most part, Council members expected the Bank of Canada to raise rates at a measured pace through 2006, resulting in an average forecast for the overnight target rate of 3.3 per cent in 2006. A few Council members expected the Bank of Canada to move to the sidelines after one rate hike in 2006. Over the medium-term, the overnight target rate was forecast to average 3.8 per cent over the 2007 to 2009 period.

The Council's average forecast for the Canadian exchange rate was 81.6 cents US in 2005, and ranged from a low of 80.2 cents up to a high of 83.0 cents. In 2006, the average of Council members' exchange rate forecasts was 82.1 cents US with the majority expecting a steady or appreciating Canadian dollar. On average, the Council expects the Canadian dollar to stabilize over the medium-term at 82.7 cents US for 2007 to 2009. Council members continued to have divergent views on the level of the Canadian dollar over the medium-term. For the 2007 to 2009 period, the range of Council members forecasts of the Canadian dollar was from 79.0 cents US up to 87.0 cents US.

The potential for further Canadian dollar appreciation was seen as one of the largest risks to the outlook. Further increases in the exchange rate bring renewed risks to growth in Canada and BC, particularly without the offset of higher commodity prices seen in 2004. Potentially negative impacts of the higher Canadian dollar would be lower exports of goods as well as tourism activity. A potential benefit of the stronger dollar mentioned by Council members was productivity enhancement through increased investment in 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.

 

British Columbia Forecast

On average, Council members expected BC's economy to post growth of 3.6 per cent in 2005, 3.4 per cent in 2006 and 3.3 per cent during the 2007 to 2009 period. Forecasts for BC economic growth in 2005 ranged from 3.0 per cent up to 4.2 per cent. All of the Council members forecast BC to outperform Canada in 2005, and almost all of the Council expected this to continue through the forecast period.

Council members cited BC's positive net interprovincial migration, sound fiscal policy, strong consumer spending and investment growth, the robust North American housing market and increased shipments through the BC transportation infrastructure, as reasons for BC's strong performance.

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

Over the medium-term, the Council noted that BC's economy would benefit from strong non-residential construction and increased trade with rapidly expanding Pacific Rim countries.

The BC outlook for the 2007-09 period showed a divergence of views among Council members. A large group (seven members) expected growth of 3.5 per cent or higher and a somewhat smaller group (five members) predicted growth of 3.1 per cent or less for 2007 to 2009 (see Chart 6).

External Issues

The Council noted the risk of a slowing global economic outlook, including growth of BC's trading partners such as the U.S., Japan and China. The trade and savings deficits in the U.S. as well as imbalances in Asia could lead to sizeable economic and currency adjustments. 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.

The Council recognized British Columbia's opportunity for significant long-term growth due to our position as a gateway to rapidly expanding Asian markets. However, several Council members stressed the importance of developing the necessary infrastructure (including improvements to ports, railways and border crossings) quickly in order to capitalize on this opportunity as soon as possible.

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. While forestry in BC was expected to continue to benefit from a strong U.S. housing sector in 2005, all of the Council members forecast the U.S. housing market to slow in 2006. The effects of the pine beetle epidemic in BC on the forest industry was also mentioned by several Council members as a medium-term issue.

Sectoral Issues

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

The Council on average expected the housing sector in BC to be robust in 2005, supported by low interest rates and increased migration from both international and interprovincial sources. The Council on average saw housing starts easing somewhat from the high levels seen in 2004 but remaining robust with an average of 32,367 units in 2005. There was a wide range of forecasts of housing starts in 2005, from 26,000 units up to 36,000 units. Over the 2007 to 2009 period, housing starts were expected to average 29,728 units with forecasts ranging from 22,000 units up to 39,000 units.

Total net migration to BC was expected to increase in 2005, relative to the level seen in 2004, with the Council's forecasts averaging 36,820 people for 2005 compared to 35,556 people in 2004. The range of forecasts for total net migration was quite wide, with a low of 30,000 people and a high of 45,000 people in 2005. Forecasts for total net migration also showed divergence over the medium-term. Total net migration was forecast to average 43,390 people over the 2007 to 2009 period, with a low forecast of 20,000 people and a high forecast of 70,000 people.

Tourism in BC has been negatively impacted by the higher Canadian dollar as well as security concerns. Council members noted that while these concerns may continue to dampen tourism in the near term, the outlook for tourism was brighter post-2006. In addition to the expected boost to tourism from the 2010 Olympics, Canada has been added to China's list of approved destinations, which should provide support to tourism in BC over the medium-term.

Several Council members mentioned high energy prices, particularly oil prices, as having both positive and negative impacts for the BC economy. High prices for oil and natural gas encourage exploration and the development of the increasingly important oil and gas industry in BC. However, the Council also noted that the high level of energy prices was a drag on external demand, which in addition to the potentially negative impact on non-energy commodity prices, would negatively impact BC's non-energy exports. Over the medium-term, development of the natural gas industry in Northeast BC was cited by the Council as a positive driver of economic growth.

Government

Council members also mentioned the improved fiscal position of government and a positive business climate as strengths in BC. The robust economic outlook for BC provides improved fiscal flexibility for the provincial government. In addition, the Council noted that the government has more flexibility to maintain a competitive tax regime and invest in infrastructure.

The top medium-term issue raised by Council members was the 2010 Olympics and potential labour constraints resulting in rising construction costs. Infrastructure projects planned for the 2010 Olympics represent a significant investment in infrastructure, and Council members expected the BC economy to benefit from the rise in non-residential construction through the medium-term. Cost pressures on materials and labour for all types of construction projects were raised as an important issue by the Council. Stronger migration to BC may help alleviate some labour shortages, but also puts further pressure on the housing market. Another labour market issue raised by some Council members was the perception of unionized labour in BC as costly and potentially disruptive.

Changes since the February 15, 2005 budget

The Economic Forecast Council has upgraded their average outlook for the BC economy from 2005 through 2009. The Council forecasts growth in British Columbia of 3.6 per cent in 2005 and 3.4 per cent in 2006, compared to 3.3 per cent in 2005 and 3.1 per cent in 2006 in January. Over the 2007 to 2009 period the Economic Forecast Council expects the British Columbia economy to grow 3.3 per cent per year.

Economic forecast council members upgraded their forecasts for BC in July for a variety of reasons. There was a general view that the BC economy has positive momentum from the strong 2004 performance and robust year-to-date data for 2005. Strong growth on the domestic side of the economy was cited by council members as one of the main reasons for upgrading their 2005 outlook. In particular, retail sales, non-residential investment and employment growth were all performing better than expected in January. Council members also noted that the outlook for net migration to BC had improved since January.

Council members also upgraded their outlook for the trade sector since their January surveys. Stronger commodity prices and a less severe than anticipated impact from the high Canadian dollar on BC exports have resulted in higher expectations for net exports over the forecast period. In addition, investment in some commodity sectors, such as mining, was expected to perform better than previously thought.