Canada – Out of the Woods, yet?

Today the Teranet National Bank Index came out, indicating that, across Canada, house prices were still rising, but the increase was decelerating (prices are rising more slowly). 

Canadians have never seen such low borrowing costs, the Bank of Canada has been raising benchmark short term rates from 0.25% to 1.0%, but at the same time, inflation expectations have abated so the yield curve has “flattened” (which means long term interest rates are falling while short term interest rates are either rising or remaining flat.  Bellow is a diagram of borrowing costs in Canada, which illustrates this point rather well.

 About 10 days ago, Tim Lane one of the BoC’s deputy governors made a presentation.  The highlights are:

• Inflation is around the 2% target range, which is right were the BoC wants it.
• Borrowing conditions for small companies are still tightening,
• GDP growth forecast for 2011 onward is for a rate of 2% instead of 3%, we got in the past decade (a function of aging population)
• Capital expenditures by Canadian companies is still way off the 2007 level, but government spending is about 10% higher than it was, and consumption is back to its pre-crisis level
• Capital expenditure may be driven by exports, which are also 5-7% lower than they were prior to the crisis.  There is still some excess capacity in the system (hence the lower investments)
• The Bank of Canada has withdrawn all of its liquidity facilities – the bank’s balance sheet is back to its pre crisis size

The question is how can Canada, a small open economy function when its major trading partner:  America seems to be slipping back into either a full blow recession or at the very least a very subdued recovery 0.5% to 1.0% growth rate.  As Martin Wolf in the FT stated in today’s Financial Times: 

In an era of deficient demand, issuers of reserve currencies adopt monetary expansion and non-issuers respond with currency intervention.

Canada’s path is far from clear, in the past when short term interest rates have diverged from those prevalent in America; Canada has had to reverse its track.  Already, Canada’s second quarter seems to be showing cracks as GDP growth appears to slip below 1%.  The only part of the economy which seems to be firing on all cylinders is the material extraction business, from oil, to copper via gold, demand for raw material is still growing, fueled by the emerging economies strong GDP growth, and their demand for raw material as they play the infrastructure catch-up game.