Part 2 – Canada and Ontario

Consumer Demand and Inflation

Consumption

Total consumption expenditure remained the bedrock of Canadian GDP growth in 2016. For the full year, total consumption expenditure advanced by 2.2 per cent to register the strongest growth among GDP aggregates. Growth was driven by household (private) consumption expenditure (2.2 per cent), but was supported also by higher government expenditure (2.0 per cent)

Higher consumption expenditure in 2016 but Canadian inflation
environment remained tame

The growth in Canadian consumption expenditure occurred in an environment in which (1) interest rates remained low and (2) the Canadian currency depreciated. However, there were other countervailing influences including lower crude oil prices and excess capacity in the Canadian economy. Together, these factors kept inflation relatively subdued.

Inflation

The annual inflation rate in the Canadian economy, as measured by the change in the Canadian Consumer Price Index (CPI), was 1.4 per cent in 2016(see figure 6). Although this was higher than 1.1 per cent registered in 2015, it was below the average market forecast of 1.6 per cent. During the year, there were a number of factors that supported higher inflation in the Canadian economy. These included:

  • The continuation of low interest rates: The low interest rate environment remained as the monetary authorities continued to provide the monetary stimulus required supporting growth in the Canadian economy. In this regard, the Central Bank’s overnight interest rate remained steady at 0.5 per cent throughout the year.
  • The sustained strength in consumption expenditure: In 2016, total consumption expenditure in the Canadian economy increased by 2.3 per cent as both private (2.4 per cent) and government (2.0 per cent) consumption increased.  
  • The depreciation of the Canadian dollar: The Canadian currency depreciated by 3.6 per cent against the US dollar in 2016. This represented the seventh consecutive year in which there was a depreciation of the Canadian currency. This meant that the cost of imported goods and services increased, resulting in higher local cost for imported goods and services.

Alongside these factors, there were others that acted to curtail inflationary pressures during the same period. These included:

  • Lower crude oil prices: The price of crude oil on the international market went down from $48.70 per barrel in 2015 to $43.19 in 2016, a decline of 11.3 per cent. The drop in crude oil price influenced a reduction in the price of gasoline. The gasoline index of the CPI fell by 6.0 per cent in 2016. However, this was less than the -16.5 per cent change registered in 2015. As a result, the contractionary influence of the fall in gasoline price on the change in average transportation cost in 2016 was less than that in 2015. The average change in transportation cost, as reflected in the transportation sub-index of the CPI, was 1.1 per cent in 2016, compared with a -3.0 per cent change in 2015.
  • The existence of excess capacity in the Canadian economy: The Canadian economy is estimated (by the Central Bank) to have continued to operate below its production capacity. With excess capacity, the economy continued to satisfy any increase in demand by employing additional resources (including labour) to increase output, with minimal impact on price.

The Canadian inflationary rate inched up in 2016 but remained tame

Seven out of the eight major sub-indices of the CPI recorded a higher index in 2016.  The increase was led by alcoholic beverages and tobacco products (3.2 per cent), shelter (1.6 per cent) and food (1.5 per cent).  However, the two major contributors to the increase in the CPI during the year were shelter and food. The shelter index increased by 1.6 per cent to contribute over 40.0 per cent of the increase in the CPI observed during the period. The 1.5 per cent rise in the average price of food is estimated to contribute over 20.0 per cent of the inflation observed.

Similar inflation patterns recorded at the national level was also observed in both Ontario and in the Toronto CMA(see figure 7). In Ontario, the average inflation rate accelerated from 1.2 per cent in 2015 to 1.8 per cent in 2016. The main contributors to Ontario’s inflation were increases of 2.7 per cent and 1.6 per cent in the average prices of shelter and food respectively. The average price of gasoline in Ontario declined by 5.5 per cent, to contain the change in the transportation sub-index to -5.5 per cent in 2016. In the Toronto CMA, the annual inflation rate accelerated from 1.5 per cent in 2015 to 2.1 per cent in 2016.

The core inflation measure, which excludes the eight most volatile items in the CPI, decelerated from 2.2 per cent in 2015 to 1.8 per cent in 2016(see figure 8). This was within the Central Bank’s inflation target range of 1.0 per cent to 3.0 per cent and suggests that the inflation environment in the Canadian economy remained tame and well within the range targeted by policy makers.


Post Period Changes and Outlook

The Canadian economy is estimated to have entered 2017 with excess production capacity. According to the Bank of Canada, “the output gap is assumed to show excess capacity of 1.4 per cent in the fourth quarter of 2016[6]”. This continued to restrain the growth in prices into 2017. In January, year-over-year change in the CPI, excluding gasoline, was 1.5 per cent. This was comparable to the 1.4 per cent increase in December 2016. The core inflation measure also registered subdued change in January at 1.7 per cent, the same as the preceding month, and again falling within the lower half of the set core inflation rate band of 1.0 per cent to 2.0 per cent (see figure 9). However, when gasoline is included, the year-over-year inflation rate in Canada in January 2016 was 2.1 per cent, up from 1.5 per cent in the preceding month. The jump in the headline inflation rate reflected the increase in the price of gasoline, up by 20.6 per cent in January. This was the largest increase since September 2011.  


The Bank of Canada projects that the Canadian economy will reach its full production capacity by mid-2018. As the economy approaches this level, inflation is expected to ease upward towards an average of 2.0 per cent.

Canadian Labour Market

Changes in the Canadian labour market will also vary with the performance of the economy(see figure 10). In the first two months of 2017, labour market changes were more positive than expected. During the two month period, total employment increased by 33,400 positions, well ahead of the 8,600 positions added during the first two months of 2015. In addition, the monthly unemployment rate fell further to 6.6 per cent in February 2016, which was the lowest rate since January 2015

As the Canadian economy approaches its production capacity, excess labour is expected to be absorbed and the national unemployment rate continue its downward trend. Current forecast is for Canadian GDP to increase by about 2.0 per cent in 2017, before accelerating to 2.5 per cent in 2018(see figure 11). Growth is predicated on a number of factors including:

  • The continuation of an accommodative macroeconomic environment: The current low interest rate environment is projected to remain in place throughout 2017 and into 2018 and continue to provide the monetary stimulus required for growth. Planned federal fiscal stimulus is expected to compliment monetary policies in supporting growth.
  • Improvement in US and global economic growth: Since the second half of 2016, US economic growth has strengthened and current expectation is for further strengthening in 2017. Planned fiscal stimulus through increased spending and reduction in personal and business tax rates are expected to help to fuel the acceleration in growth expected. The IMF projects that the US economy will lead growth among developed economies in 2017 with a 2.3 per cent economic expansion and help to lift global growth from 3.1 per cent in 2016 to 3.4 per cent in 2017. As an open economy, heavily reliant on trade activities particularly with the US, stronger global and US economic growth is expected to stimulate growth in the Canadian economy.
  • Recovery in crude oil prices: Since the agreement on supply quota in late 2016, the average price of crude oil has increased. As global growth picks up, further increases in the price of crude oil are likely, and should benefit the economies of oil exporting countries like Canada.

The forecast for growth in the Canadian economy in 2017 and into the medium term is associated with numerous risks. In the domestic economy, the growth in residential investment is likely to be negatively affected by recent increase in mortgage rates and new measures put in place by the government to reduce risk in the housing sector. Externally, the main risk relates to the new inward looking trade policy stance of the US government, including a stated intention to renegotiate the North America Free Trade Agreement (NAFTA). Such trade policies, if materialized, are likely to have negative repercussions for the Canadian (and Ontario) economy. Research has shown that trade restriction by the US will likely impact Canada negatively, with Ontario among the Canadian provinces that would be most impacted.

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