Others expect short recession and sharp rebound

Alia McMullen, Financial Post
Published: Monday, February 02, 2009

The federal government’s fiscal stimulus package, while eventually expected to exert some positive economic influence, will not prevent Canada’s slide into a deep recession in 2009, said David Wolf, the Canadian economist and strategist at Merrill Lynch.

He said the Bank of Canada will consequently lower interest rates to an effective 0% and step up efforts to ease credit conditions as the recession worsens.

Mr. Wolf said while the fiscal stimulus package would benefit the economy, the amount of stimulus was not unprecedented and would not be enough to spark a strong recovery in 2010, as projected by the Bank of Canada.

He said a large part of the government’s projected $34-billion deficit for fiscal 2009, which is equal to 2.2% of GDP, was a result of the normal deterioration in revenues during a recession. He said the cost of new initiatives was about $18-billion, which is “nearly identical” to the measures put in place in the 2007 budget.

“Net marginal stimulus provided in the budget comes solely from allowing the ‘automatic stabilizers’ to work, which is surely a positive for the economy, but can’t plausibly play a dominant role in producing strong rebound in 2010,” he said.

Mr. Wolf, who was already one of the most bearish economic forecasters in the market, said the continued deterioration in economic data has caused him to increase his outlook for economic contraction to 1.7% for 2009 from his prediction of a 1.2% decline in December. He said the weaker projection largely reflects a further decline in consumer spending as well as continued shaky housing investment. The estimate is far bleaker than the Bank of Canada’s outlook for a 1.2% contraction this year.

He said the continued deterioration of economic activity would have a negative impact on inflation, resulting in the Bank of Canada slashing rates to an effective 0% and holding them there until growth resumes, possibly in 2010.

“In the meantime, expect the BoC to participate more directly in the program of ‘credit easing’ which the federal government expanded further in Tuesday’s budget,” Mr. Wolf said.

Mr. Wolf also rejected the central bank’s expectation for a strong economic rebound in 2010. He forecast GDP to rise 2.4% next year compared with the Bank of Canada’s outlook for a 3.8% rebound.

Mark Carney, the governor of the Bank of Canada, said last week he expected the government’s 2009 federal budget to provide significant stimulus to the economy. He said the domestic package combined with fiscal stimulus around the world and signs of an improvement in credit markets would help facilitate a strong economic recovery in 2010 as global demand picked up.

The outlook for a short recession and sharp rebound has merit in the eyes of Stefane Marion, the chief economist and strategist at National Bank. He said Canadian interest rates were the lowest ever entering into this recession, a proactive move that would act faster to kick start growth.

“It is very likely that the Canadian recession of 2008-09 will be shorter than the previous two, despite the fact that the present U.S. recession will be the longest since 1960,” he said. “If we consider all the U.S. and Canadian recessions since 1960, never has the real policy rate of either central bank been lower at the outset of a downturn than where Governor Carney and his team managed to bring it this time around.”

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