The Canadian economy picked up strength during the spring. GDP growth for the first quarter was 1.3%. However, in the last three months to April, our growth was up 3.2%. (Clearly, January was a weak month.) Leading the economy during this period were the Goods Producing Industries which were up 7.7%. The GDP forecast of 2.0% for 2018 and 2019 looks to be achievable. Strength is coming from Business Investment which should be strong throughout the year. Business confidence as measured by the Bank of Canada (BofC) remains very high. The Canadian labour market is in good shape; our unemployment rate for June was 6%. This rate is expected to decline slowly towards year end to 5.6%. Wage growth which supports consumer spending was up 3.5% over the past year. Core inflation is expected to remain well contained in the 1.9 – 2.0% range for the balance of 2018 and into 2019.
According to the BofC estimates, our economy currently is operating near full capacity. As a result, the BofC is shifting their monetary policy to a neutral position (not so low to stimulate the economy but not too high to restrict growth). The actual neutral interest rate is a fuzzy number; somewhere between 2.5 and 3.5%. Given the strong economy and moderate inflation, it came as no surprise that the BofC increased the Bank Rate on July 11th to 1.5%.
The greatest risk to the Canadian economic forecast is a trade war with the U.S. NAFTA is not likely to be agreed upon until after the U.S. mid-term elections in November. If the Trump administration continues to place more tariffs on imported goods our growth rate will slow, inflation will rise and the BofC will be on hold.
Notwithstanding a trade war and solid economic growth, the BofC is likely to follow the U.S Federal Reserve when it increases the Fed Fund rate. The Fed is expected to increase the Fed Fund rate two more times in 2018 taking it to 2.5%. Canada should maintain the .5% lower Bank Rate, therefore, our Bank Rate should be 2% by year end.
Canadian bond yields year to date have moved higher but in a volatile manner. For example: the Canadian government ten year bond yield began the year at 2.03%. At March 31, the yield was 2.11%. However, it reached a high of 2.37% on February 2. In the second quarter the ten year Canada bond yield hit a high of 2.52% on May 17 but finished the quarter at 2.13%.
For the second quarter and the first half, the Provincial bond sector performed the best. Over the past year, Corporate A bonds performed best.